Term Insurance for Startup Founders - An insight into Keyman Insurance

• Introduction
• What is Keyman Insurance?
• Who is eligible for keyman insurance?
• What happens when this employee quits the organization?
• How to buy the right keyman insurance policy?
• What are the tax implications?
• Differences between Key Man Insurance and Personal Term Life Insurance?

Founders. Entrepreneurs. Leaders. CEOs. They have something more in them than your average employee. They are driven, purposeful, and have a plan for how their business should scale, make money, and thrive. Setting up the very foundations for the success of the organization - their contributions run deep to create a definitive vision for the business’ present and future.

While entrepreneurs strive for growth, they also have a responsibility to secure the people who back them, support them, and have possibly sacrificed an established career, to join them. And, as they work towards building the best-case scenario with full conviction, it is possible that they remain unprepared for the worst-case. 

One such worst-case scenario most founders completely overlook, is that a key person, managing critical responsibilities at their startup dies due to a freak accident or illness. What happens in such situations - who pays the rent, the salaries, the dues payable to vendors, etc.?

Enter - Keyman Insurance.

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While it is challenging to develop internal mechanisms that de-risk the sudden absence of the commander, de-risking its financial implications might be easier than you thought!

Keyman insurance is a type of term insurance policy taken by an organization, to cover the risk of their key-employee, leader, or founder passing away. The organization applies for the policy and pays the premiums on a periodic basis. At the same time, the organization will be the beneficiary of the policy, receiving the death benefit if the keyman’s death happens during the tenure of the policy.

Keyman insurance is a simple and straightforward way to minimize the financial disruption and losses caused to the organization by a key employee's death and giving the team the opportunity to cope, re-organize and facilitate business continuity and growth. Its proceeds can also be used for the unfortunate winding up of the company - liquidation costs, including salaries, vendor payables. The remaining money, if any can be distributed to shareholders.

Also this:

It’s not uncommon for VCs to insist that a startup take out a key person policy on the person or people whose expertise is critical to the company’s current operations and future success. The rationale for the request is that should a key person suddenly die, the business would either collapse or be so crippled that it would have to take a huge step back to reboot and rebuild. - Key Person Insurance Is VCs’ Assurance

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Any organization that is profitable (or startups that are well-funded) can take this cover for their key employees. This includes sole proprietorships, partnership businesses, private limited companies as well as trusts & foundations.

To be eligible, the company should have been in existence for at least three years and audited for the last three years. Further, they should have filed income taxes for at least the last three financial years. In case of partnerships, the organization should have a partnership deed with at least two partners.

Businesses can take keyman policies for multiple key persons based on their role and significance in the company’s future. If a company is an LLP or is in partnership, every active partner can be treated as a Keyman.

To be considered a key-person, an employee will need to fulfill the following eligibility criteria.

• Holds less than 51% stake in the company
• Total shares held by the employee and their family members shouldn’t be more than 70% of the total share capital of the company
• Their role should be critical for the success of the business (this needs to be justified to the insurance company)

But remember, the employee is only the ‘insured’ in this whole transaction. Both the roles of paying the premiums, as well as claiming the insurance amount is done by the organization itself.

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Such policies only last until the employee retires or finishes their employment-term. Similar to any term insurance, the organization doesn’t get anything back if the employee survives the term. In case the employee quits or moves to another employer, the organization can choose one of the following possibilities for the insurance policy, subject to insurers' internal policies.

1. Stop paying the premiums - and let the policy lapse.
2. Re-assign the policy back to the employee - the policy will now be a regular term life policy, owned by the employee with beneficiaries as employee's family members.
3. Transfer the policy to the new employer of the employee - the policy continues in the employee’s new organization.

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First, you will need to find out the cover eligibility. At this moment, there is no facility to customize the keyman insurance cover amount. To decide the cover value, insurers take the lowest among these -

• 10 times the annual package of the keyman
• 3 times the average gross profit that the company has earned in the last three years.
• 5 times the average net profit that the company has earned in the last five years.

Next, a company representative should connect with an insurance company or an intermediary for an initial assessment. During this phase, the insurer will estimate the insurance requirements of the organization and gather documentation to verify it.

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The company will be able to claim a tax benefit for the premiums paid in this type of policy. On the other hand, the claim amount received as a death benefit will attract a tax.

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Do note that Keyman insurance does not replace a personal term life insurance policy that you take to financially secure your family. The money received from Keyman insurance will be utilized by your employer or startup.

Here's a quick list of differences between Keyman insurance and personal term life insurance.

A keyman insurance policy provides financial protection to any business in case any one of its key employees dies prematurely. Although this policy cannot replace the skillset, knowledge, and leadership of the key employee used to put on the table, it can provide the business with the funds to deal with the loss and replace that employee with another one and train them.

Therefore, a keyman insurance policy is very important and should not be ignored.

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