Key person insurance for startups

Startups need key man life insurance to protect their growing business from financial losses caused by the death of an important executive.

Congratulations! You have a great product, a viable business plan, and you’re ready to introduce your business to customers and investors. But you may be forgetting an important part of your business plan: key person insurance.

Key person insurance (also called key man or key employee insurance ) is a life insurance policy owned and paid for by a business, which also serves as the policy’s beneficiary. It protects a business from financial losses if a person central to the business—usually the founder, owner, or CEO—dies.

During business planning, startups often skip over buying life insurance. But key person insurance is essential to mitigate risks that could damage or bankrupt a new business. A licensed insurance agent or financial advisor can help you get the right protection for your company.

Key Takeaways

  • Startups can use key person insurance to fill financial gaps after the death of a co-founder or executive

  • Key man life insurance can be term or permanent insurance, though term will be more affordable

  • Not all providers sell key man insurance to startups, which may have difficulty proving financial viability

  • Startup leaders should also consider buy-sell agreements, cross-purchase agreements, and entity purchase plans to protect their business

What is key person insurance?

Key person insurance is a life insurance policy taken out on a crucial employee of a business. The business is the owner and beneficiary and pays the premiums.

A key person policy pays a death benefit to the business if a critical employee dies. The payout can be used to:

  • Absorb losses in revenue following the death

  • Cover outstanding business loans 

  • Fund the recruitment and hiring of a replacement 

  • Provide severance if the business ceases operations

You can use term life or permanent life insurance in a key man insurance agreement. If you or your loved ones will get some of the benefits of the policy, it’s known as a split-dollar life insurance agreement. 

→ Compare term and permanent life insurance policies

Key person insurance vs. personal life insurance

Key person insurance does not replace a personal life insurance policy, as the money from key person insurance rarely goes to family members. If you have key person insurance through your business, you still need a personal life insurance policy.

A key employee policy replaces your contributions to your business, but a personal insurance policy replaces your financial contributions to your household. Make sure you buy enough personal life insurance to account for any business debts that might fall to your family when you die.

→ Learn more about personal life insurance for business owners

How startups can purchase key person insurance

Buying key man insurance is much like buying an individual policy, with one main exception: the financial underwriting portion focuses on your startup’s finances. Even though many investors require startups to have key person insurance, it can be difficult to purchase if your company lacks revenue. 

A Policygenius agent can recommend an insurer that writes coverage for startups and guide you through the application process.

Financial underwriting for key person insurance

Just as your health risks impact your life insurance premiums, your startup’s financial risk will affect your key person insurance application. 

When buying key person insurance for an employee, insurers evaluate your startup’s overall financial situation and the business value of the key employee you’re insuring. They may ask for:

  • Annual sales figures

  • Estimated cost to replace key employee

  • Fair market value of the company

  • Net profit of the business

  • Tax statements

  • Total compensation of key employee

Because of the perceived financial risk, some life insurance companies don’t offer key person insurance to startups. But others are more flexible, especially if you can prove that your business is growing and has a clear path to viability.

After you choose an insurance company, applying for key person insurance is identical to applying for a personal policy. The person to be insured will answer questions on the application and undergo a medical exam. That information, along with other records, determines your premiums.

→ Learn more about the life insurance application process

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Do startups need any other life insurance agreements?

Key person insurance is a great way to protect your business from losing a vital employee, but it works best in tandem with additional business life insurance products. To give your startup the most comprehensive protection, pair a key man policy with:

  • Buy-sell agreement: Like a will or prenup for your business, these define what happens if a co-owner leaves the company or dies. This includes purchase terms and pricing for the exiting or deceased owner’s shares.

  • Cross-purchase agreement: Paired with a buy-sell agreement, this allows business partners to buy life insurance on each other. If one dies, the surviving owner uses the death benefit to buy the deceased’s share of the business.

  • Entity purchase plan: An entity purchase plan sets the terms under which the business may use the death benefit from a key person policy to purchase a deceased employee’s shares.

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Any business, large or small, might struggle after losing an important employee. Startups are even more vulnerable to those risks because co-founders or owners are more difficult to replace because of their expertise or personal networks. A death benefit can’t replace the next Jack Dorsey or Anne Wojcicki, but it can help you stay afloat in case anything unexpected happens.

Talk to a licensed insurance agent and financial advisor to make sure you have the right financial protection from day one.

Key person insurance for startups FAQs

Who is a key person to a startup?

Anyone who is integral to the startup’s operations and whose absence would cause revenue loss can be considered a key employee. That includes any co-owners, founders, and executive members like CEOs and CFOs.

What type of insurance should startups use for key man life insurance?

Any type of life insurance can be used for a key man policy. Most companies use term or whole life insurance.

How can startups use the death benefit from key man insurance?

The tax-free lump sum can be used for any business expenses, including recruiting, client retention, loan payments, or buying out the deceased’s shares.