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What startup founders needs to know about purchasing key person insurance.
Startup founders who are shopping for funding from venture capital companies may find that they need to purchase key person insurance, which is often listed as a requirement on the funder’s term sheet.
Key person insurance is a life insurance policy that is owned by a business and names that business as the beneficiary. It ensures that the business can continue to operate even if a central person in the business — usually the founder — dies.
It can be complicated for startups to qualify for key person insurance because they usually haven't made any profits or revenues yet, but it's not impossible.
Key person insurance, also called key man insurance, is the same product as a traditional life insurance policy; the differences lie in who owns, pays for, and is the beneficiary of the policy.
Key person insurance ensures that if the founder of the company — or any other key player in the company’s operation — dies, the company will receive a death benefit to allow it to continue operations. The death benefit can be used to help absorb losses in revenue the company may face and provide cash to help the search, recruitment and onboarding of a new executive.
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.
Example for a startup co-founder named Sarah.
|Key person insurance||Personal life insurance|
|Beneficiary||The business||Sarah’s family and dependents|
|Who pays premiums?||The business||Sarah|
|Is the benefit taxed?||No||No|
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Even though many funders require key-person insurance, it can be difficult for startups to purchase it because they don’t usually have the revenue yet to prove financial justification.
Life insurance companies require financial justification for key person policies because no one should be worth more dead than alive. (They require it for personal policies, too — you can only buy a personal policy for 10 to 20 times your salary, for example.)
Some life insurance carriers simply won’t offer key insurance to startups. Other carriers are more open to working with startups, especially when presented with a narrative that explains that the business is growing and has a clear path to viability.
An advisor at Policygenius can recommend a carrier who is open to the changing trends in business and willing to write coverage for startups. We can also help you organize your application so it's most likely to be approved.
After you choose a carrier, applying for key person insurance is very much like applying for a personal policy. The person to be insured will need to answer questions on the application and undergo a medical exam. That information, along with other records, will be reviewed by underwriting and the insured will assigned a health class, which will determine rates. Tne insured and the policy owner will both sign the policy, and the policy owner will pay the premiums.
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