Running a small business often means wearing multiple hats. But behind every successful operation, there are usually one or two people whose knowledge, relationships, or leadership are absolutely critical to the business’s success. If something unexpected were to happen to them, the financial impact on the business could be significant.
This is where key person insurance comes into the conversation.
What is key person insurance?
Key person insurance (sometimes called key man insurance) is a type of business insurance designed to protect a company from the financial consequences of losing an essential team member due to death, disability, or serious illness.
The policy is typically owned and paid for by the business, and the business is also the beneficiary. If the insured key person is unable to work or passes away (depending on the policy terms), the business receives a lump sum payment.
Importantly, this is not about replacing the person emotionally or operationally overnight — because that’s rarely possible. Instead, it is about providing financial breathing room during what could otherwise be a very disruptive period.
Who is considered a key person?
A key person is anyone whose absence would materially impact the business. In small and medium-sized businesses, this often includes:
- The founder or owner
- A rainmaker responsible for major client relationships
- A highly specialised technical expert
- A senior manager whose leadership drives operations
In many small businesses, the owner themselves is the key person — particularly where client relationships, intellectual property, or decision-making are heavily concentrated in one individual.
Why it matters for small business owners
Small businesses are often more vulnerable than larger organisations when a key person is lost. Larger companies may have deeper benches, stronger cash reserves, and more formal succession planning. Small businesses, on the other hand, can be heavily dependent on a handful of people.
Key person insurance can help address several potential risks.
- Protecting cash flow
If a key person is suddenly unavailable, revenue can fall while expenses continue. The insurance proceeds can help cover ongoing costs such as wages, rent, loan repayments, and supplier commitments while the business stabilises.
- Supporting business continuity
Replacing a key team member takes time and money. Recruitment fees, training costs, and the productivity gap during transition can all add up. Insurance funds can help support the search and onboarding of a suitable replacement.
- Reassuring lenders and stakeholders
Banks, investors, and even major clients often take comfort knowing that the business has a financial safety net in place. In some cases, lenders may even require key person cover when approving business loans.
- Protecting business value
For owner-operated businesses, the loss of a key individual can reduce the overall value of the enterprise. Having appropriate protection in place can help preserve business value and provide options during a difficult period.
Why professional advice is important
While the concept of key person insurance sounds straightforward, the structure and purpose of the cover can be more complex than many business owners realise.
Key considerations can include:
- Determining who should be insured
- Calculating an appropriate level of cover
- Deciding how the policy should be owned and funded
- Understanding potential tax implications
- Aligning the cover with buy–sell agreements or succession plans
Getting these elements wrong can lead to underinsurance, inappropriate ownership structures, or unexpected tax outcomes.
This is why seeking advice from a qualified financial adviser and appropriate tax professionals is so important. A tailored approach ensures the cover aligns with the business’s financial position, ownership structure, and long-term strategy.
The bottom line
Key person insurance is not about expecting the worst — it’s about sensible risk management. For many small business owners, the business and the people behind it are deeply interconnected. Protecting against the financial shock of losing a key individual can be the difference between a business that survives disruption and one that struggles to recover.
If your business relies heavily on specific individuals (and most small businesses do), it may be worth having a conversation with a professional adviser to explore whether key person protection forms part of a broader, well-structured risk management plan.
If this article has inspired you to think about your unique situation and, more importantly, what you and your family are going through right now, please get in touch with your advice professional.
This information does not consider any person’s objectives, financial situation, or needs. Before making a decision, you should consider whether it is appropriate in light of your particular objectives, financial situation, or needs.
(Feedsy Exclusive)
Disclaimer: The information contained in this article is general in nature and does not take into account your personal objectives, financial situation or needs. Please consider whether the information is appropriate to your circumstance before acting on it and, where appropriate, seek professional advice.