Why startup founders need key person insurance

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Why startup founders need key person insurance

So, you’ve watched too many episodes of Silicon Valley and have decided to found a startup. Awesome! Let me guess: you spend a lot of time on this startup. And when I say a lot of time, I mean all of your time. And when I saw all of your time, I mean you live and breath this business.

Without you, your company would cease to exist. This isn’t just me being overdramatic – your company is simply too young to survive the loss of a founder.

That’s why you shouldn’t be surprised to see something called "key person insurance" on the term sheet of a Series A or B fundraising round. Well, you might be surprised if you’ve never heard of key person insurance (sometimes called key man insurance).

So what is it? Key person insurance is a life insurance policy, but instead of the death benefit going to a spouse, partner, child, or trust, it goes to the company. The company will pay the premiums, too.

The death benefit can be used by the company in two major scenarios:

  • It can provide a buffer period where the company can look for new leadership.

  • If your company decides to close, it can be used to pay off debts, investors, and give a severance to employees.

In both cases, the company uses the death benefit to give itself time to regroup after a tragic loss.

Now it probably makes sense why it’s required on your term sheet, right? Your investors are pouring millions (and millions) of dollars into your business, but they’re not just investing in the business – they’re betting on the founder’s vision.

Investors may want to insure more than one key person. An example: let’s say your startup relies on a specific person’s expertise and losing that person would set your company back years or make it impossible to deliver on your goals. You’d want them covered by key person insurance.

Key person insurance does not replace a personal life insurance policy, as none of the money from key person insurance would go towards family members.

It’s easy to get key person insurance – any life insurance broker or agent can sell you a key person insurance policy. (The only thing that turns a life insurance policy into a key person insurance policy is that it’s bought and paid for by the company.)

Image: Rohan Gandhi