How To Protect The Downside Of Your Business

“Screw it, Let’s Do It” is Richard Branson’s most famous quote and also the title of his international best-selling book. Coming from the founder of the Virgin Group and perhaps one of the world’s most successful entrepreneurs, this may suggest that reckless abandon is a good thing when it comes to starting up a business. Throw caution to the wind, set sail, take the leap, just do it, etc.

Here is a less publicised quote from the same man, “As an entrepreneur you should be willing to take risks and trust your judgment when you do, but you always have to think about the worst-case scenario.” In fact, he admits that “protecting the downside” was amongst the best advice he had ever been given.

First of all, let’s agree that like most things in life, businesses follow a cyclical pattern. It is the cyclical nature of business that makes downside protection key to the long- term success of any venture. Riding both the ups and downs in the cycle will get you nowhere, to be successful and achieve growth over the long- term you must ride the ups and avoid the downs.

Surprisingly, many entrepreneurs bury their heads in the sand when it comes to downside protection. Let’s face it, it doesn’t have the appeal of the upside. It is far more exciting for an entrepreneur who is just starting out or a group of partners in a successful SME to spend their time thinking about the growth aspects of the business, like increased sales and expansion.

But what are some of the downsides that could befall a start-up or an established business, and what can be done to protect the entrepreneur?

PARTNERSHIP PROTECTION

Consider the following scenario: You are a partner in a two-partner firm, with each partner owning 50 per cent of a company with $10 million in equity. Your capital is tied up in the business – let’s say a factory or a restaurant. Your partner dies.

What would happen next? Well, after a short grieving period you would be approached by the bereaved family of your now-deceased partner, who will be looking for their $5 million. If you haven’t planned for this eventuality, how would you come up with $5 million to buy out your partner’s share in the business?

Partnership protection, coupled with a buy/sell agreement, provides the required funds and mechanism to seamlessly transfer ownership of the deceased’s share to the surviving partner.

BUSINESS LOAN PROTECTION

If your business has taken out a bank loan, the critical illness or death of you of one of your partners may put the company’s ability to repay that loan at risk. If your business is in this precarious position, then you should consider business loan protection.

Business loan protection caters very specifically to this need. A good example is decreasing cover, which reduces the amount of cover over time proportionally to the outstanding debt, making it a very cost effective means to protect your business from its debt burden.

For example, if you have borrowed $100,000 with a 10-year repayment plan, your cover would start at the full $100,000 and decrease over the course of the 10 years in line with the outstanding debt.

There are countless stories of widows and widowers who have been burdened with their spouses’ business debts. Do not make your loved ones a part of that statistic.

WIND-UP PROTECTION

It is a grim thought for any entrepreneur to consider failure right out of the gate. Statistically, however, the failure rate of businesses is alarming. According to Bloomberg, 80 per cent of businesses will not make it past the first 18 months of operation.

Would it not make sense for an entrepreneur to consider this possibility and plan to deal with it effectively?

In the UAE, startups and SMEs must consider the costs associated with winding up the company. One of those costs will be the end-of-service benefits (gratuities) that their employees will be entitled to under UAE labour law (UAE Federal Law No. 8 of 1980).

Good practice dictates accruing the company’s end-of-service benefit liability in a ring-fenced account, but the fact
is that most businesses fail to meet this standard. Instead, the cash is tied up in the company’s working capital
in the hope that general cash flow will suffice when the odd person ends his or her employment relationship with the company and is due a payment.

There are cost-effective corporate solutions to manage and fund end-of- service liabilities and turn them from a burden to a resource. Instead of being an ever-growing hole in your balance sheet, it turns the end-of-service liability into a self-funded employee retention tool that will motivate your employees and reward them for their loyalty.

All the while, the business owner can be comfortable in the knowledge that he or she is protected from the financial impact of winding up the business should the need arise.

KEY PERSON PROTECTION

This is also commonly known as key- man insurance. A budding business will typically depend on a key person to get it up and running, and to keep it on its feet in its incubation period and beyond. This could be the founder of the company or a key sales person responsible for a large proportion of company sales.

How would it impact the business financially if this person were to get hit by the proverbial bus?

People drive businesses, and the key person would have established trust and goodwill and ultimately built relationships that lead to sales. How long would it take a business to replace the key person and bring the newcomer up to speed? What will keep the business afloat in the meantime?

The appropriate level of key person protection will provide the company with a lump sum that will keep the business ticking until a suitable replacement is brought in and brought up to speed.

ENTREPRENEURS DESERVE A LITTLE PEACE OF MIND

Ask any entrepreneur and they will tell you that navigating the business landscape is not an easy task. It is an immense challenge to build a business from scratch, and perhaps an even greater challenge keeping it afloat once it has left the ground.

There are innumerable risks involved, many of which cannot be insured against, like political risk, increased competition, commodity price risk, regulatory risk, a damaged reputation, and business interruption due to unforeseen circumstances.

Nevertheless, business men and women can take solace in the fact that there are risks that can be easily and very cost-effectively managed, some of which we have covered in this article.

So, what is the process for identifying and prioritising the risks associated with your business?

THE STEPS

1) Seek a qualified financial adviser
2) Identify and list the potential risks
3) Rank the identified risks by the likelihood of their occurrence:

-Very likely to occur
-Some chance of occurrence
-Small chance of occurrence
-Very little chance of occurrence

4) Address risks most likely to occur It may be impossible, or impractical from a cost perspective, to cover all of the risks simultaneously. An adviser will help you to prioritise and address the risks in the most efficient manner.