You have built a startup. You have a brilliant co-founder or a lead developer who wrote 90% of the code. In the eyes of investors, these people are not just employees; they are the business.
What happens if one of them dies unexpectedly or becomes permanently disabled? Usually, the business collapses.
To prevent this, smart companies (and almost all Venture Capitalists) require Key Person Insurance (formerly known as Key Man Insurance). It is the ultimate survival plan for your company.
1. What is Key Person Insurance?
It is essentially a life insurance policy taken out on a specific individual, but with a twist:
- The Company buys the policy.
- The Company pays the premiums.
- The Company is the beneficiary.
If the key person dies, the insurance company pays a tax-free lump sum (e.g., $1 Million or $5 Million) to the business. This money is used to hire a replacement, pay off debts, or buy out the deceased partner's shares.
2. Who Counts as a "Key Person"?
Not every employee needs this. It is reserved for people whose absence would cause a significant financial loss. This includes:
- The Founder/CEO: The face of the company.
- Top Salesperson: The one bringing in 50% of revenue.
- Lead Engineer: The only person who understands the core product.
3. Why Investors & Banks Require It
If you are trying to raise Series A funding or get a massive business loan, get ready to buy this policy.
Investors want to know their money is safe. If the genius behind the idea dies, they want their investment back. This insurance provides that liquidity.
4. Key Person Disability: The Overlooked Risk
Most people think of death, but a disabling injury is statistically more likely.
Key Person Disability Insurance works the same way. If your top coder gets into a car accident and can't work for a year, the policy pays the company enough cash to hire an expensive temporary consultant to keep the ship moving.
Pro Tip: Compare this with Standard Disability Insurance, which pays the employee directly.
Running a business involves many risks. Make sure you also have Workers' Compensation in place for your regular employees.
5. How is it Taxed? (Important!)
The tax rules for Key Person insurance are different from regular business expenses.
- Premiums: Generally NOT tax-deductible. You pay them with after-tax dollars.
- Payout (Death Benefit): Generally Tax-Free. When the company receives the $1 Million check, it usually doesn't pay income tax on it.
FAQ: Protecting Your Business's Future
1. How much coverage do I need?
A common formula is: Cost to replace the person + Contribution to revenue x 5 years. If a salesperson brings in $200k profit a year, you might insure them for $1 Million.
2. What happens if the key person leaves the company?
The company can usually transfer the policy to the employee (as a parting bonus), or simply cancel it. If it's a "Term Life" policy, it just expires.
3. Is it expensive?
It depends on the age and health of the key person. Term insurance for a healthy 30-year-old founder is very cheap (maybe $50/month for $1M coverage).
4. Can we use the money for anything?
Yes. Once the payout hits the company bank account, it can be used for hiring, paying off investors, or even closing the business down smoothly.
5. Is this part of a Buy-Sell Agreement?
Yes, often. Partners use this insurance to fund a "Buy-Sell Agreement." If Partner A dies, the insurance money allows Partner B to buy Partner A's shares from their family.
Disclaimer: Tax laws regarding company-owned life insurance (COLI) are complex. Always speak with a CPA and corporate attorney before purchasing.