Why You Need Key Man Insurance

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

By Keith Lowe • May 5, 2006 Originally published Oct 10, 2002

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 yourplate, and it seems like you spend all your time working on theurgent stuff--trying to get your product or service ready, hiringpeople, figuring out how to increase sales, paying the bills and soon. It's hard to find the time to consider something thatisn't really urgent but that can be incredibly important, suchas insurance--specifically, "key man" insurance.

Key man insurance is simply life insurance on the key person ina business. In a small business, this is usually the owner, thefounders or perhaps a key employee or two. These are the people whoare crucial to a business--the ones whose absence would sink thecompany. You need key man insurance on those people!

Here's how key man insurance works: A company purchases alife insurance policy on the key employee, pays the premiums and isthe beneficiary of the policy. If that person unexpectedly dies,the company receives the insurance payoff. The reason this coverageis important is because the death of a key person in a smallcompany often causes the immediate death of that company. Thepurpose of key man insurance is to help the company survive theblow of losing the person who makes the business work. The companycan use the insurance proceeds for expenses until it can find areplacement person, or, if necessary, pay off debts, distributemoney to investors, pay severance to employees and close thebusiness down in an orderly manner. In a tragic situation, key maninsurance gives the company some options other than immediatebankruptcy.

If the company is just you and doesn't have any employees orother people who depend on it, then key man insurance isn't asnecessary. You'll notice that I didn't mention yourfamily--don't confuse key man insurance with personal lifeinsurance. If you have a spouse and/or children who depend on yourincome, then you should have personal life insurance for thatpurpose.

How do you determine who needs this insurance? Look at yourbusiness and think about who is irreplaceable in the short term. Inmany small businesses it is the founder who holds the companytogether--he may keep the books, manage the employees, handle thekey customers and so on. If that person is gone, the businesspretty much stops.

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

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

Most people, particularly when they're young, don't planon dying suddenly. If you are working to start or grow a smallbusiness, you've got plenty on your mind, and chances are youhaven't thought much about key man insurance. But take it frommy experience: By the time you need it, it is too late to doanything about it. Call an insurance agent today, figure out howmuch key man insurance your company needs and buy it!

Keith Lowe is an experienced entrepreneur who is a founderand investor in companies in several industries. Lowe also mentorsnew entrepreneurs; serves as past chairman of the board forBiztech, anonprofit high-tech business incubator; and is a co-founder andofficer for the Alabama Information Technology Association.

The opinions expressed in this column are thoseof the author, not of Entrepreneur.com. All answers are intended tobe general in nature, without regard to specific geographical areasor circumstances, and should only be relied upon after consultingan appropriate expert, such as an attorney oraccountant.

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