Protecting your business
Almost all SMEs rely on one or two important individuals in order to manage and keep the firm going. So the obvious question arises; what will happen to the business if these important individuals or key people are not able to continue working due to unforeseen or unavoidable circumstances. Dr. Ashraf Mahate, Head of Export Market Intelligence, Dubai Exports, and Vice Chair of the Economic Policy Committee, Dubai Economic Department, talks to us about what SMEs can do to protect our business when and if such a situation arises.
The most immediate impact of the loss of a key person within a business is a decline in revenue. More often than not, the key person within SMEs tends to have a direct relationship with suppliers and customers and is responsible for generating revenue. In a highly competitive environment, where such relationships are not maintained effectively, it is most likely that competitors may take over the customer.
In the domestic market it is common to have more than one key contact with a supplier or customer. However, in the international market, due to organisational constraints and the sheer geographical distance it is normal for SMEs to appoint a single point of contact. Very often there is no secondary contact point for overseas suppliers and customers. This implies that very large revenue streams may be reliant on the relationship of a single person within the firm.
Most SMEs incorrectly believe that if the key contact within the firm was to leave, a suitable replacement could easily be found without any impact on their external relationships. The reality is that a suitably qualified and experienced replacement can be recruited in a short space of time. However, relationships take a long time to develop and build. This is more so the case in overseas markets, where cultures and business norms are very different to the home market.
It is most probable that the new staff member will take some time to develop and nurture relationships. Even if a replacement to the key person is found, the business incurs costs associated with the recruitment process. Estimates show that recruitment costs tend to be about 20% of the annual salary. Then there is the training period, during which additional sums will be needed to be spent to ensure that the replacement is able to continue from the key person. SMEs tend not to have such contingency funds available for unexpected costs.
The departure of staff is one form of key person risk that SME exporters need to be aware of and equally, if not more important, is that fact that the owner himself might not be around. This poses a considerable risk to the SME exporter because in most cases the exporter would have signed contracts stating agreed delivery dates and other details. On the basis of this, the importer would have initiated a letter of credit, which requires the exporter to provide certain documents, such as delivery of goods on the specified dates, quantity and quality of products, bill of lading and so on.
However, with the departure of the key person it is most probable that production will be affected. The disruption in production may impact on the firm’s ability to deliver the goods as per the agreed schedule. This will in turn hamper its ability to meet the terms on the letter of credit and of course receive. If the company has obtained pre-shipment finance on the basis of the letter of credit, then it may not be able to meet its financial obligations. As is often the case with SME financing, they tend to be guaranteed by the owner’s personal assets. Hence, the absence of that individual can suddenly place not only the business, but also the owner or his family at risk.
A risk-averse SME exporter needs to take precautionary measures in order to safeguard the long term interests of the business in the event of such a situation. The usual manner in managing this type of risk is to purchase ‘key person insurance’, which is now available in the UAE, through both domestic and international firms. Essentially, the key person insurance allows the business to continue to meet its financial obligations in the event of a serious illness or death of a key person.
Depending on the type of coverage purchased, key person insurance can pay all outstanding trade and loan creditors, including releasing the key person or his family of any personal guarantees and meeting the costs associated with either closing the business or selling it. Such an insurance coverage allows the key person to ensure that the business imposes no risk to their personal assets, while allowing it to continue operating or be sold off in a proper manner.
Simply purchasing key person insurance is not enough, as the SME needs to ensure that it protects against the appropriate risks as well as providing a sufficient level of coverage. Valuing the importance of a life is never easy; however, what is possible is to determine the loss that will be suffered by the business.
In other words, what the impact will be on the sales, costs, productivity and efficiency of the firm? Whether it is possible to find an appropriate replacement and if so, what will be the associated costs and time period? What is the level of average trade and loan creditors outstanding at any one period including personal guarantees? What will be the costs associated with winding down the business or selling it? Of course these questions are quite difficult and may require expert opinion from an accountant or insurance professional. Despite their unpleasant nature, SMEs need to answer these questions because inadequate insurance is just as bad as not having it.
Key person insurance is only one component of a comprehensive risk management strategy, which SMEs need to implement. However, it is important to note that insurance covers only the financial risk that an exporter faces but not the disruption or the loss of business that can take place. SMEs looking to avoid such risks need to be pro-active and establish processes and procedures to ensure that the departure of key people does not hamper their export activities.
As in most cases, SMEs only realise the importance dealing with the loss of key people after the event. Therefore, it is extremely important that SMEs implement appropriate contingency planning that takes into consideration the worst eventuality.
Dr. Ashraf Mahate is the Head of Export Market Intelligence at Dubai Exports (formerly known as the Dubai Export Development Corporation), which is an agency of the Dubai Economic Department. Dr. Mahate is also the Vice Chair of the Economic Policy Committee with the Dubai Economic Department. He has written a number of journal articles, chapters in books and edited books in the areas of economics, finance and banking. He has also presented papers at major international conferences. Dr. Mahate has provided extensive consultancy services to various organisations in the areas of banking, economics and finance. He has been a director of a number of companies including a venture capital company and a private equity fund.
Dr. Mahate received his doctorate from Cass City University Business School in London (UK) which was ranked by the Financial Times newspaper as the 12th best university in the world for finance. He read Economics at University College London, followed by a Masters in International Economics and Banking at the University of Wales in Cardiff. Dr. Mahate is a professional educator and received his training at the Institute of Education (University of London). He is a member of the Chartered Institute of Managers (UK) and a Member of the Institute of Commercial Management (UK). He is also a member of the Association of Certified Anti-Money Laundering Specialists (ACAMS).