Does your small business need key person insurance?
If losing one specific person would cost the business real money before it could recover, then yes. Key person insurance is a policy the business owns on that person, with the business as beneficiary, so cash arrives at the moment revenue does not. It is not about ownership and it does not replace a buy-sell agreement. It buys time: to recruit, to reassure a lender, and to keep operating while somebody learns what that person knew.
Ask one question
If this person did not come in on Monday, permanently, what would it cost before the business recovered?
If the answer is "not much, we would manage," you do not need key person insurance on them, and anyone telling you otherwise is selling. If the answer makes you go quiet, you have found your key person.
It is often not the owner
Owners assume this is about them. Sometimes it is. Just as often the person who would hurt most to lose is the one who holds the customer relationships, or the estimator who prices the jobs correctly, or the single technician certified on the machine that runs your busiest line.
A useful test: who could take three of your best customers with them, not through malice but simply because those customers deal with that person rather than with your company? That is a key person whether or not they own a share.
What the money is actually for
People imagine it replaces the person. It does not. It buys the time to replace them, which is a different and more honest thing.
| The gap | What it costs | How long it lasts |
|---|---|---|
| Revenue that walked out with them | Gross profit on work that does not get quoted, sold, or delivered | Until a replacement is producing, often six to eighteen months |
| Recruiting and training | Search costs, a higher salary than you were paying, and a learning curve | One-off, but larger than most owners budget for |
| Lender confidence | A line of credit reviewed or called at the worst moment | Immediate, and often the sharpest problem |
| Everyone else watching | Good employees leave during uncertainty, which compounds the first problem | First ninety days |
A worked example
A machine shop with eleven employees. The owner runs the business, but the person who prices every job is a foreman who has been there nineteen years and quotes from experience nobody has written down.
He dies. Within a month the shop is either quoting too high and losing work, or quoting too low and losing money, and nobody knows which until the jobs come back. The bank notices the numbers. Two good machinists start returning calls from a competitor.
A key person policy does not bring him back. What it does is put cash in the business the month it is needed, so the owner can pay above market to bring in an experienced estimator, absorb a few mispriced jobs while that person learns the customers, and tell the bank the situation is funded.
Same loss. The difference is whether the business gets a year to recover or a quarter.
The part owners get wrong
Buying it and forgetting it. The key person in a business changes. The person who was irreplaceable in 2019 may have trained three people since, and the new hire who has quietly become essential is not on any policy.
The other one is coverage that never grew. A policy sized for a business doing two million is not sized for the same business doing five.
Where we fit
We work out with you who genuinely qualifies, what the gap would actually cost rather than what a multiple suggests, and how the policy should be owned so the money lands in the right place. Your CPA confirms the tax treatment, because employer-owned policies carry notice and consent requirements that need doing correctly and in advance.
This is general education about how key person coverage works, not tax advice and not a recommendation about your business.
While we are on the subject.
Who counts as a key person?
Anyone whose absence would visibly cost the business money. Often the owner, but not always. It can be the salesperson holding the relationships, the estimator nobody can replace, or the one technician certified on the equipment you run.
Who owns the policy and who gets the money?
The business owns it, pays the premium, and is the beneficiary. The money arrives at the company rather than the family, which is exactly the point. Family protection is a separate policy doing a separate job.
How much coverage does a business need?
There is no formula that survives contact with a real business. The honest method is to add up what the gap would actually cost: lost gross profit while you recover, the cost of recruiting and training a replacement, and any debt the bank could call. We work that out with you rather than applying a multiple.
Is the premium tax deductible?
Generally no, and because the premium is not deducted the proceeds are generally received free of income tax. There are exceptions and notice requirements for employer-owned policies, so your CPA needs to confirm the treatment for your business before you buy.
Do we need this if we already have a buy-sell agreement?
Often yes, because they solve different problems. A buy-sell moves ownership. Key person coverage keeps the business running while ownership is being sorted out. A business can need both, and they are usually funded separately.
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