Executing a vision takes great ideas, maximum effort, and talented people. Part of that process is ensuring against potential threats with effective risk management strategies. Key person start up cover is essential coverage that protects your business from the financial impact of losing a key individual or the business owner, securing your venture’s future.
One of the most significant risks faced by new ventures is the potential loss of key personnel, those individuals whose unique skills and vision are integral to the company’s growth. Without a plan to mitigate this risk, even the most promising start-up can face serious setbacks.
This is where key person insurance comes into play. You can easily secure the financial protection needed to ensure your start-up thrives, even in the face of adversity. This coverage not only safeguards your business but also fortifies its foundation for long-term success.
Key Takeaways of Key Person Insurance for Start-Up Companies
- Critical Financial Safeguard for Start-Ups: Key person insurance acts as a vital safety net, protecting start-ups from the severe financial impact of losing essential personnel. It ensures business continuity by providing the necessary funds to cover operational costs, recruitment, and potential revenue losses.
- Investor Requirement for Funding: Many investors and lenders, including venture capital firms and private equity, mandate key person insurance as part of their funding agreements. This coverage not only protects their investment but also boosts investor confidence, making it easier for start-ups to secure funding.
- Tailored Key Man Insurance Coverage for Unique Circumstances: Traditional key person insurance may not always be suitable, especially for start-ups with unique needs or challenges. Alternative policies like Accidental Death or Key Man Disability Insurance and Contract Performance Indemnity can provide tailored solutions, ensuring comprehensive protection under special circumstances.
- Multiple Methods for Valuing Key Employees: Start-ups can use various approaches to determine the appropriate amount of key person insurance, such as multiples of salary, replacement cost, contribution to revenue, and equity preservation. This flexibility allows businesses to accurately assess their coverage needs.
- Underwriting Complexities for Start-Ups: The underwriting process for key person insurance in start-ups is more complex due to the lack of established financial history. Providing detailed management bios, financial projections, and a well-crafted cover letter can help justify coverage amounts and secure favorable terms.
- Leverage Industry Expertise to Simplify the Process: Every insurance company evaluates risk in its own way, which is why it is so important to team up with an experienced insurance professional to choose the best company for your insurance needs.
What is Key Person Insurance?
Key person insurance is a type of life or disability insurance policy that a business takes out to cover its most critical employees. In the event that a key employee dies or sustains a disabling illness or accident, the business receives the policy proceeds.
This payout is crucial for maintaining cash flow and stability during overwhelmingly challenging times. Key person insurance can be seen as a safeguard for any new venture, ensuring the company can withstand the loss of essential personnel and keep the vision intact.
Traditional Key Person Insurance Policies
Life Insurance
Key person life insurance policies come in various forms, but for start-ups, term life insurance is often the most suitable option. Term insurance is affordable and provides coverage for a specific time period, aligning with the needs of a burgeoning business. A 10-year term life policy is a tremendously effective solution to protect against key man risk for start-up organizations. It has very low costs and is not hard to acquire in most cases compared to permanent life insurance policies.
Key Person Disability
In addition to life insurance, it’s also essential to consider disability insurance. Since illness or injury is more likely than death at most ages, having a policy that covers disability is crucial for comprehensive protection. This ensures that the business is protected not just in the event of the key person’s death but also if they are unable to work due to an accident or sickness.
Alternative Coverage for Special Circumstances
A traditional keyman insurance policy is not always a viable solution. In some instances, specialized coverage must be secured to manage the risk effectively. Special circumstances that may preclude getting conventional key person insurance could be a pre-existing medical condition, limited markets, coverage requirements exceeding capacity, or simply the need to get coverage fast.
In these cases, policies like Accidental Death or Disability, Contract Performance Indemnity, Contract Frustration Insurance, or Failure to Survive insurance may be used to mitigate risk. These types of policies are especially useful for start-up companies that have unique contractual requirements from Venture Capital and Private Equity investors.
By understanding and implementing key person life and disability insurance, start-ups can maintain integrity, attract more investment, and secure their company’s future against unforeseen circumstances.
What is the difference between an ordinary life insurance policy and a key man life insurance policy?
The only real differences between a basic term life insurance policy and a key person life policy are the policy owner and the named beneficiary. The coverage options are identical, and the price for like policies is essentially the same.
With personal life coverage, the policy owner can be the Insured, another individual, or a Trust. The policy owner of a regular life policy can name his or her beneficiary of choice including an individual, multiple people, the Estate of the Insured, or a Trust. As stated, for start-up organizations, a term life insurance policy is the most effective protection.
Key Employee Insurance: How It Works
The structure of a key person insurance policy is straightforward. The business purchases and pays the premiums for a life or disability insurance policy on the life of the key employee. In return, the life insurance company provides a promise to pay a benefit to the business if the covered employee dies or becomes disabled.
The employee is required to acknowledge that the business will buy and own the insurance and be the beneficiary in the event of a claim. A Notice and Consent for Employer-Owned Life Insurance must be signed by the employee and the individual representing the company. The key employee has no rights to the policy and normally receives no direct benefit.
Importance of Key Man Insurance for Start-Ups
Devastating Impact of Losing a Key Person
Losing a key person can cripple a start-up company. The sudden absence of a Founder, Chief Executive Officer, Inventor, or Chief Technology Officer will disrupt daily operations and may abruptly halt the execution of the company’s vision.
Start-ups often rely heavily on a few key employees whose unique skills and knowledge are essential for the business’s success. The key person’s contribution to daily operations, execution of strategy, and ultimate profitability could be painful to replace. Without key person insurance, the financial burden of losing a core member of your new venture could lead to severe cash flow problems and jeopardize the company’s future.
Requirement for Funding
Key man insurance is a crucial requisite for securing funding from investors or lenders. Many Seed Investors, Venture Capital (VC) firms, and Private Equity (PE) companies recognize the importance of key employee life and disability insurance and contractually require it as part of their funding arrangements.
Many Angel Investors stake companies on the ideas and talents of one or two key people. In these cases, key man insurance policy is an essential tool to provide peace of mind and remove anxiety. It ensures that the business can continue to operate smoothly even if a key employee dies or becomes disabled. Key person insurance coverage is a safety net, which increases investor confidence and promotes a willingness to invest.
Key man insurance can be used to protect a business in various ways. For example, it can provide benefits to pay off business debt, cover recruitment costs for a replacement employee, pay business expense, and maintain the company’s cash flow. In some cases, the death benefit from the insurance policy can be used to stabilize the business during a transition period. However, it isn’t designed to make an investor “whole” or recoup lost investment.
Following is an example of actual contract language for a loan agreement that describes the key employee life and disability insurance requirement:
(From and after 30 days following the Closing Date and until Borrower has paid Lender in full for all of its Obligations, Borrower shall maintain one or more life insurance policies on the life of the Key Employee in form and substance acceptable to the Lender, having a combined death benefit in an aggregate amount that is sufficient to pay all the Obligations as they come due, with the Lender named as the beneficiary. Insurance proceeds of such life insurance policies will first be used to satisfy Borrower’s Obligations until fully paid. (iii) From and after 30 days following the Closing Date and until Borrower has paid Lender in full for all of its Obligations, Borrower shall maintain one or more disability insurance policies on the Key Employee in form and substance acceptable to the Lender, having a combined disability benefit in an aggregate amount that is sufficient to pay all the Obligations as they come due, with the Borrower named as the beneficiary. Insurance proceeds of such disability insurance policies will first be used to satisfy Borrower’s Obligations until fully paid.
How to Identify Your Key People
With start-ups, a key employee is probably one or two obvious contributors that the company cannot afford to lose such as a technical guru, AI specialist, programmer, or inventor. These are the people whose ideas and experience have been the incubation of the entire business plan. They make strategic decisions, drive innovation, and manage the business’s overall direction. These individuals are often very difficult and may be impossible to replace with one person.
It is crucial to evaluate each key person’s contribution and secure appropriate insurance coverage to safeguard the company’s future.
How to Value a Key Employee
Insurance companies use several methods to financially underwrite key man insurance. The four main approaches are listed below:
- Multiples of Salary Method
All insurance companies commonly use the multiples of salary to establish coverage limits. The idea is that salaries reflect the true value of the individual. For example, a 15 X multiple of income is a reasonable guide. However, using this approach alone can sometimes present a challenge for very young companies whose executives are taking a reduced salary.
- Replacement Cost Method
What is the cost to hire and train a capable replacement? Smaller companies usually have one or two people who have a complete vision for the company and the experience to execute it. In these instances, recruiting the right person may take time and considerable resources. Make sure you account for these extra costs.
- Contribution to Revenue Method
The contribution to earnings method calculates the key man insurance needs using the estimated percentage of a key employee’s contribution to the company’s bottom line. For example, a top salesperson in a small business may contribute 50% or more of total revenue. In this case, it is vital that your top salesman’s revenue contribution is factored into your key person coverage. This method is more common with established businesses.
- Equity Preservation Method
What is the estimated Fair Market Value? With seasoned companies, it is common to add the value of the equity interest of the key person in the amount of coverage required. With start-ups, it is significantly more difficult to measure value since there is no significant track record of revenue.**
How Much Key Person Insurance Does a Start-Up Need?
Defining the right amount of coverage for a newly formed business is a bit more subjective than with an established business. The obvious reason is that most new businesses are pre-revenue with only projections based on assumptions in a business plan or ProForma.
For a practical approach, refer to the key man insurance calculator on our website. Our proprietary tool is a guide to help you estimate the amount of key person insurance your start-up needs based on specific considerations like the unique skills of your key employees, the difficulty of hiring a capable replacement, and projected revenues and earnings.
Key Person Insurance Quotes and Due Diligence
After the company identifies its key contributors and determines how much coverage it needs on each, the next step is figuring out how long the insurance will be required. In many instances, there is a definable period of time for the need, usually 3-5 years. Short-term policies are usually very inexpensive and fulfill investors’ requirements.
Every insurance company views risk differently, which means identifying specific health and lifestyle details is crucial for getting the best rate. One medication, a few extra pounds, or a family history of death from heart problems may impact rates significantly. Working with an experienced insurance broker who understands the underwriting landscape is vital to nailing down the “pre-underwriting” questions prior to choosing the insurance company and making an application.
How Much Does Key Man Insurance Cost?
The cost of key man insurance policy depends on several factors, including the insured’s age, health, tobacco use, coverage amount, and other lifestyle factors. The sample rates below include coverage amounts for $500,000 and $1,000,000 for 10-year guaranteed-level term protection. All rates are quoted annually and can be paid monthly, quarterly, or semi-annually.
For instance, a $500,000 key man-term life insurance policy might cost a healthy 40-year-old key employee approximately $200 annually, while a $1 million policy could cost around $300 annually. These costs can vary based on the specific circumstances of the insured person and the insurance company’s criteria.
Disclosure: Rates quoted are the top health class and actual rates will vary significantly based on age, gender, smoking status, and specific health conditions. Quotes illustrated may vary in certain states. Labs may be required, but no medical exam options may also be available at these rates.
What is the Process to Buy Key Person Insurance?
Once the right insurance company is identified, the next step is to apply for coverage.
Buying a key person policy for a start-up involves a few logical steps. There are multiple paths to securing coverage including instant decision coverage, accelerated underwriting without labs, and the traditional application process (for age 65 and older). The right path depends upon your specific situation, coverage needs, and insurance company requirements.
The Application Process (General Overview)
When applying for key man insurance, basic identifying information about the insured and the business (policy owner) will be required.
| Employee Information | Company Information |
| Date of birth Social security number Driver’s license Income Equity/Role Existing Life Insurance Lifestyle:, Scuba, Piloting, Etc. Foreign Travel Driving Record Family History Health Details | Exact Entity Name Physical Address Entity Type, C Corp, S Corp, LLC, Etc. Employer Identification Number Inception Date Capitalization table for all owners above 10% in equity Existing key man Insurance Financials including Assets, Liabilities, Net Worth, Gross Revenue, and Net Income Approximate Fair Market Vale |
Typical Underwriting Process for Start-ups
“Underwriting” is simply another word for evaluating a risk.
During the underwriting process, an insurance company compiles information about the insured key person and thoroughly reviews it to classify risk and assign a health class. This is how the ultimate rate for the coverage is determined. For a thorough review of this process, see our Comprehensive Guide to Underwriting Key Person Life Insurance.
Medical and Lifestyle Underwriting
Lifestyle and Medical factors are two of the most critical parts of life insurance underwriting process.
- Lifestyle: Insurance companies consider lifestyle factors such as occupation, hobbies, and habits. For example, a key person who regularly engages in high-risk activities like scuba diving, skydiving, or mountain climbing may face higher key person insurance premiums. Private aviation also falls under this category. Things like driving records, criminal history, and past overuse of drugs or alcohol are also considered.
- Medical History: Insurance companies will thoroughly investigate an insured’s medical history to determine the ultimate rate for key man insurance. Conditions like heart disease, diabetes, or cancer will increase the cost of coverage or may even lead to a denial.
Since COVID-19, insurance companies have been trying to avoid sending a nurse out to gather personal medical information. Instead, they now either conduct a detailed telephone interview or provide a link to a secure online portal allowing the insured to provide their own information. Depending upon the answers provided, insurance companies may request electronic health records or medical records from attending physicians.
What Health Class will I qualify for?
Every insurance company has its own proprietary underwriting guidelines it uses to categorize an individual risk and ultimately to offer a rate. There are various names for these health classifications, but they are essentially the same categories. The generic underwriting classes are listed below:
- Preferred Plus Non-Tobacco: Top Health Class (approximately 20% of the population qualifies*)
- Preferred Non-Tobacco: Second Best Health Class (the next 15% of the population qualifies*)
- Standard Plus Non-Tobacco: Third Best Health Class (the next 15% of the population qualifies*)
- Standard Non-Tobacco: Average Health Class ( the next 25-30% of the population qualifies*)
- Rated Health Class: Individuals have a more serious health condition that exceeds the average risk
- Smoker, Tobacco, and Vaping Classes
What determines an individual’s health class really comes down to the insurance companies’ own view of risk. No two insurance companies will see a certain risk exactly the same, and the rates between insurance companies will likely be different for the exact same condition.
Every situation is unique, and even the healthiest individuals can miss out on the best health class if they apply with the wrong company. For example, an insured with a family history of a natural parent’s death prior to age 60 from a heart attack may result in a Preferred Non-Tobacco rate for one company while others will offer a best-case Standard Non-Tobacco. The difference in rates could be thousands of dollars.
Unique Underwriting Requirements for Start-Ups
Many start-ups are pre-revenue and lack an established track record. This complicates company valuation and, as a result, the financial justification of key person insurance. As previously mentioned, an insurance company wants to assess the risk accurately given its guidelines, which may not always match investors’ expectations of available coverage. In these cases, you will likely need to find creative ways to establish the value of a key person.
Management Bios
When applying for coverage, it is important to provide the insurance underwriter with detailed management bios of the top people. These bios should highlight their qualifications, experience, and past salary history. In many new companies, key people take a reduced salary. Bios can include previous achievements to show their true value allowing them to justify the coverage amounts needed. LinkedIn profiles and even “About Us” credentials from the corporate website can be very helpful.
This information helps life insurance companies assess the risk and determine the appropriate insurance policy and coverage value. In many cases, Venture capitalists and Private Equity ask for substantial amounts of key person insurance that may not be justified with many insurance providers. Working with an experienced broker is crucial to secure maximum protection.
Financial Data, Speculation, Valuation
All companies applying for key man insurance, including start-ups, will be required to present financial data. Normally, this is a balance sheet and profit and loss statement for the last 12-24 months. If this is not available, a business plan, ProForma, and maybe even a 409A can be provided. This data is essential for life insurance companies to understand the business’s potential and market expectations. It is the primary way insurance companies assess the justification and true risk of key man insurance.
Additional requirements may include current capital raised and valuations at the Seed Stage of financing and Series A and B Rounds. These valuations consider the company’s current and projected market value. Accurate and detailed financial documentation supports the underwriting process and helps justify coverage limits.
A Supporting Cover Letter that Paints the Perfect Picture
For start-ups, it is imperative to work with an insurance professional who knows how to present the “case” to the insurance company’s decision-maker. A carefully crafted letter that describes the nuances of the application helps the underwriter clearly understand the purpose of the coverage assuring the best results. This includes not only securing the lowest rate but also the true amount of coverage required to adequately protect the risk.
By understanding these underwriting complexities, start-ups can better navigate the process and secure the necessary funds to protect their business against unforeseen events.
Answers to the Most Frequently Asked Questions (FAQs) About Key Person Insurance Coverage for Start-Up Companies
What Does a Key Person Policy Cover?
A key person insurance policy protects a business from the financial impact of losing a key employee due to death, accident, or illness. The insurance proceeds can be used for a variety of reasons including covering the costs of hiring and training a capable replacement, maintaining cash flow and repaying business debt.
What is the best keyman life insurance company?
The best keyman life insurance company for your company will depend upon several factors including the amount of coverage required, the health and lifestyle of the employee, and how fast the coverage is required. An insurance broker that is an expert in key man insurance is recommended.
How long does it take to get a key man life policy? Can I get a policy fast?
The time it takes to get a key person insurance policy can vary based on several important factors, such as the insured’s age and health, the amount of coverage, and the complexity of the insurance need.
If the insured is 65 or younger, in good health, and needs less than $5 million in coverage, coverage could potentially be approved for a key person policy in less than 48 hours.
Instant Decision, “yes” or “no” option may be available in limited situations. With these plans, you can be approved within a few minutes.
Anyone over age 65 will likely be required to complete labs as part of the process, which could take a couple of weeks.
If you have a chronic health condition, such as diabetes, hypertension, anxiety disorder, a heart condition, or cancer history, the process will take longer, anywhere from 3-6 weeks. In these cases. Electronic Health Records are required and labs will likely be needed. In these cases, it is wise to speak with a key person insurance expert.
Do I have to do a medical exam for key person insurance?
Many companies now offer a fluid-fee or lab-free option if certain conditions are met. For example, if you are age 65 or younger, you may be able to avoid medical exam labs for insurance if you have had a complete physical exam with your Primary Care Physician in the last 12 months that included labs.
When applying for key man life insurance, there are three possible paths, each with numerous options. Navigating the process effectively requires an experienced broker specializing in business-owned life insurance.
What if I have a pre-existing medical condition?
In most cases, pre-existing medical conditions do not limit the ability to buy Key Man life insurance. Diabetes, heart disease, high blood pressure, high cholesterol, obesity, sleep apnea, and even some cancer histories can get affordably priced coverage.
What are the tax consequences of keyman life insurance?
Generally, the proceeds of a key man insurance policy are not taxable to the business. However, depending on how the policy is structured, there may be exceptions.
Conclusion and Summary of the Complete Guide to Key Person Insurance for Start-Up Companies
The success of any business startup often hinges on the contributions of a few key individuals, key person insurance is more than just a safety net, it’s a strategic necessity. By investing in this coverage, start-ups can protect their vision, secure investor confidence, and pave the way for sustainable growth.
Key person insurance is an indispensable tool for start-up companies, offering vital protection against the financial repercussions of losing a key employee. This insurance is not only a safeguard for the business’s future but also a critical requirement for securing funding from investors and lenders.
By understanding the different types of key person insurance, how to value key employees, and navigating the underwriting process, start-ups can effectively manage risk and ensure long-term success.
As you continue to build your startup company, ensuring the right key person insurance is in place will provide peace of mind and the financial stability needed for future growth.
Protect the Financial Future of Your Start-Up Company Now: Free No-Obligation Key Person Insurance Quote
Your start-up’s success depends on the talent and vision of your key people. Losing a vital team member can have devastating financial consequences, but with key person insurance, you can safeguard your company’s future. By securing the right coverage, you ensure that your business continues to thrive, even in the face of unforeseen challenges.
With expert guidance from us at MEG Financial, Inc. and Keypersoninsurance.com, you can navigate the complexities of key person insurance easily and effortlessly. Invest in your company’s stability and secure the protection you need to move forward with confidence.
Don’t leave your start-up vulnerable. Contact us today for a free, no-obligation insurance quote tailored to your specific needs.
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