Key-Person Insurance is a life or disability insurance policy taken out by a company on a key-person within the company. The Key-Person insurance policy itself is nothing exotic, it’s a standard life or disability insurance contract. For life coverage, typically it will be a term insurance policy, perhaps a 10 or 15 year policy. The differences in procedure revolves around the documentation since a company will own the policy as well as be the beneficiary.
Who is a Key-Person?
A key-person is a person within an organization that without which, that company would be in trouble. Examples of a key-person could be an executive such as a CEO or COO, an employee that has exceptional technical knowledge essential to the company like a CTO or key engineer or a key salesperson without which significant revenue would be lost.
The shared attribute of the examples is that if the executive, techie or sales chief was gone tomorrow there would significant damage done to the organization as a whole.
What is Key-Person Insurance for?
The insurance would secure the company against potential losses that derive from the death or disability of such a key person.
For starters, it would insure the company against the expense of replacing a key person. An executive search to replace a key officer can be time consuming and expensive. The insurance coverage would mitigate the company’s financial risk.
The coverage would also insure against potential lost revenue due to the loss of the Key-Person. As a for instance, if a key salesperson were gone tomorrow, what would that mean in terms of sales revenue lost. If a key executive with a litany of strategic contacts and relationships were gone tomorrow, what would that be worth in dollar terms?
The amounts of coverage needed comes down to the potential revenue lost and the cost to find and train a suitable replacement.
When should a company have Key-Person Insurance
Probably the most common trigger for procuring this kind of coverage stems from VC funding as quite often it will be a prerequisite to closing out a deal. Outside investment will be apt to want to mitigate the risk of the death of a key-person in a company they may be investing in.
In the absence of an outside trigger, companies need to take stock of their own employee’s value. As a company grows and scales, there will be those certain employees upon which a company relies heavily. It is up to leadership to identify such employees and protect against the loss of those employees.
If this is an issue your company faces, here comes the shameless plug. I work on these issues quite a bit with companies facing this need. If it is something your company faces and warrants some guidance, feel free to reach out. I will be happy to act as a resource.
At a very early stage it won’t be a necessity but that doesn’t make it a bad idea to have sooner rather than later. A buy/sell agreement will go a long way toward getting ahead of issues down the road. If a founder wants to leave a startup, sell a stake, becomes disabled and can’t work…. or dies, the buy/sell agreement will map out how the shares of the company are to be valued and to whom they can/will be sold.
Why is a Buy/Sell Agreement Important?
This becomes more important as a company grows, is generating revenue and has a significant value attached to it. At this point there can be real money at stake and as the money gets bigger, the potential ramifications to all parties involved increases.
A buy/sell can become one of those forgotten tasks, one of those things everyone says they need to do but growing the company, hitting deadlines, moving things forward get in the way. Often something happens unexpectedly and all the sudden you have a dumpster fire of a situation on your hands.
Amending a Buy/Sell Agreement
Getting an agreement mapped out early on sets parameters right from the start. The agreement can be flexible and amendments can be made. Maybe another founder or outside money enters the mix. Maybe a founder wants to buyout another founder. If the valuation of a company gets to the point to where one founder can’t buy out another, funding an agreement with insurance is going to become a key factor. You can change an existing agreement, in fact it’s something that should be reviewed regularly and amended to suit.
You can’t amend something that never existed though, and you can’t turn back the clock if a situation occurs and such an agreement has never been placed. If you do it early on when you are establishing associated items such as the Founding/Operating Agreement, a lot of the details will fall into place logically toward a buy/sell. Just grind it out and take care of it, save yourself an inevitable problem down the road.
If you’ve read this far and feel this is something you could use more guidance on, here comes the shameless plug. I work with my clients in the startup space quite often on getting buy/sell agreements together and getting them funded. If it is something you could use some help with feel free to reach out. I’d be happy to act as a resource.
Business Insurance & Investment Services of MA