Key person cover: protecting the business you have built

In many owner-managed businesses, a small number of people hold the customer relationships, the technical knowledge or the lender’s confidence. If one of them is suddenly gone, revenue can fall, projects can stall and banks can call in facilities, all at the moment the business is least able to cope.

What key person cover is

Key person cover is a life or critical illness policy that the business takes out on an important individual. The business owns the policy, pays the premiums and receives the payout. The money can be used however the business needs: to replace lost profit, recruit and train a successor, reassure customers or repay debt.

Who needs it

Ask a simple question: if this person were gone tomorrow, what would it cost the business? Key people are often:

• the founder or managing director
• the person who brings in most of the revenue
• a technical expert whose knowledge is hard to replace
• anyone whose personal guarantee or presence underpins a bank facility

In some cases the decision is made for you. Some lenders require key person cover before they extend credit to an owner-managed business.

If this person were gone tomorrow, what would it cost the business?

How much cover

There is no single formula, but most calculations start from one or more of:

• the profit the individual generates, multiplied over the time it would take to replace them
• the cost of recruiting and training a replacement
• the loans or facilities that depend on them

Insurers will want the amount to be justified by the business’s accounts, so it helps to work it out with your adviser and accountant.

Key person cover and business credit

One of our clients needed new credit lines to grow his business. His lenders would only agree them if the company held substantial life cover on him. We arranged USD 8 million of key person cover with UAE-based insurers, structured to meet the lenders’ requirements, and the facilities were agreed. The cover protected the business and unlocked its next stage of growth.

Protecting the owners, too

Key person cover protects the company. A related need is protecting the other shareholders. If a co-owner dies, their shares usually pass to their family, who may want cash rather than a stake in a business they do not run.

Shareholder protection deals with this. Each owner is insured, and an agreement between the shareholders gives the survivors the option to buy the shares, funded by the policy. The family receives fair value quickly and the remaining owners keep control.

Practical points

• Ownership and beneficiary. For key person cover, the business should own the policy and be its beneficiary.
• Tax. Whether premiums are deductible and how a payout is taxed depends on the country and how the policy is set up. Check the treatment with your accountant, especially if the business operates in more than one jurisdiction.
• Review. As the business grows, the right amount of cover changes. Review it at least every few years, and whenever you take on significant new borrowing.