Why You Need Key Man Insurance

Growth Strategies

Even if you’re just starting out, it’s important to protect your business with the right insurance.

October
7, 2002

5 min read

Opinions expressed by Entrepreneur contributors are their own.

Q:
What is key man insurance, and does my new business need it?

A:
When you’re just starting out, you’ve got a lot on your
plate, and it seems like you spend all your time working on the
urgent stuff–trying to get your product or service ready, hiring
people, figuring out how to increase sales, paying the bills and so
on. It’s hard to find the time to consider something that
isn’t really urgent but that can be incredibly important, such
as insurance–specifically, “key man” insurance.

Key man insurance is simply life insurance on the key person in
a business. In a small business, this is usually the owner, the
founders or perhaps a key employee or two. These are the people who
are crucial to a business–the ones whose absence would sink the
company. You need key man insurance on those people!

Here’s how key man insurance works: A company purchases a
life insurance policy on the key employee, pays the premiums and is
the beneficiary of the policy. If that person unexpectedly dies,
the company receives the insurance payoff. The reason this coverage
is important is because the death of a key person in a small
company often causes the immediate death of that company. The
purpose of key man insurance is to help the company survive the
blow of losing the person who makes the business work. The company
can use the insurance proceeds for expenses until it can find a
replacement person, or, if necessary, pay off debts, distribute
money to investors, pay severance to employees and close the
business down in an orderly manner. In a tragic situation, key man
insurance gives the company some options other than immediate
bankruptcy.

If the company is just you and doesn’t have any employees or
other people who depend on it, then key man insurance isn’t as
necessary. You’ll notice that I didn’t mention your
family–don’t confuse key man insurance with personal life
insurance. If you have a spouse and/or children who depend on your
income, then you should have personal life insurance for that
purpose.

How do you determine who needs this insurance? Look at your
business and think about who is irreplaceable in the short term. In
many small businesses it is the founder who holds the company
together–he may keep the books, manage the employees, handle the
key customers and so on. If that person is gone, the business
pretty much stops.

How much key man insurance do you need? That depends on your
business, but in general you should get as much as you can afford.
Shop around and get rates from several different agents; most life
insurance agents will sell you a key man policy. Be sure to ask for
term insurance–many agents will push whole or variable life, which
have much higher premiums and commissions but are unnecessary for a
key man policy. Ask for quotes on $100,000, $250,000, $500,000,
$750,000 and $1 million and compare the costs of each. Then think
of how much money your business would need to survive until it
could replace the key person, come up to speed and get the business
back on its feet. Buy a policy that fits into your budget and will
address your short-term cash needs in case of tragedy.

Let me share an example from my own personal experience. My
brother-in-law started a golf vacation
business
in the winter of 1997. Tommy worked many long hours
for almost three years, and it looked like all his hard work was
paying off. Then one night he was killed in a car wreck. He was 35
years old. As my wife and I tried to deal with the magnitude of
that loss, we also had Tucker Golf’s employees, vendors and
customers to think of. No one planned for this to happen. But it
did happen, and we had to pick up the pieces. Tommy did not have
key man insurance, and the company struggled for almost two years
before it recently got back on solid footing. While key man
insurance wouldn’t have brought Tommy back, it would have taken
a major worry away from his grieving family and employees.

Most people, particularly when they’re young, don’t plan
on dying suddenly. If you are working to start or grow a small
business, you’ve got plenty on your mind, and chances are you
haven’t thought much about key man insurance. But take it from
my experience: By the time you need it, it is too late to do
anything about it. Call an insurance agent today, figure out how
much key man insurance your company needs and buy it!

Keith Lowe is an experienced entrepreneur who is a founder
and investor in companies in several industries. Lowe also mentors
new entrepreneurs; serves as past chairman of the board for
Biztech, a
nonprofit high-tech business incubator; and is a co-founder and
officer for the Alabama Information Technology Association.

The opinions expressed in this column are those
of the author, not of Entrepreneur.com. All answers are intended to
be general in nature, without regard to specific geographical areas
or circumstances, and should only be relied upon after consulting
an appropriate expert, such as an attorney or
accountant.

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