Key Man

Key Person Insurance & CFI for Late-Stage Companies

Carl Niedbala
Updated: Sep 20, 2024

TL:DR

Key Takeaways

Managing Partner; COO & Co-Founder

Essential team members can make a significant contribution to a company’s success, no matter its size. However, late-stage companies are unique, influencing an array of individuals. When a key person passes away, it often leaves investors, team members, and clients grasping for a clear path forward. Here’s a look at insurance products that focus on a critical member’s death or total disability and how companies can swiftly recover from such a devastating loss.

What Is Key Person Insurance?

Key person insurance is the traditional way companies create a financial cushion for themselves if a key member of the team suddenly dies. It’s a life insurance policy that a business purchases on an essential team member or executive’s life. The company serves as the primary beneficiary and pays the premium. The policy works as a pure life insurance policy, offering the death benefit.

Typically, surviving family members use the death benefit to cover funeral expenses, burial arrangements, or even outstanding debt. However, surviving team members usually use the insurance payout for more business-related chores. The deceased’s family usually covers end-of-life planning. Recruiting, hiring, and training a new team member are examples of tasks a key person insurance payout would cover.

Sometimes a company can’t carry on without that key member, or the remaining team members can’t find a replacement. In this case, the payout can also help pay debts, severance benefits, issue funds to investors, and shut the business down as painlessly as possible. In other words, it allows companies to consider options other than insolvency.

Companies that purchase key person insurance would face significant financial loss if a key member passed away. Key team members could be founders, owners, CEOs, board members, etc. Regarding late-stage companies, critical executives are often named the key person because of their impact on the company.

What Is Contract Frustration Insurance?

Another option for covering key team members is contract frustration insurance (CFI) — but it’s likely not the exact product you read about via a Google search. Our sister, Scale Underwriting, offers CFI specifically designed to protect high-growth companies and investors from the impact of a key member’s death or total disability.

Like key person insurance, CFI provides funds to cover various costs relating to losing a key member. But it’s often challenging for management to estimate how a key team members’ death will impact the company. Scale’s CFI offers a valuable calculation called “ascertained net loss” to help businesses peg these precise numbers.

Unfortunately, losing a key person can cause companies to miss milestones, decrease in value, and force them to raise more venture capital (VC). Getting operations back on track isn’t merely a quick fix. Backed by Loyd’s of London, Scale’s CFI meets the same “key person insurance” many institutional investors require.

Key Person vs. CFI

Key person and contract frustration insurance cover many vital risks that small, mid-sized, and late-stage companies face. To help you decide which coverage is suitable for your high-growth business, here’s a helpful breakdown of the policy details Founder Shield offers.

Key Person vs. CFI Comparison

	Traditional Key Person Insurance	Contract Frustration Insurance
Length of Term	Standard options include 1, 5, and 10-year terms. Most carriers are in the ten-year space (with annual payments), so there are fewer options if you'd like a shorter term.	This policy is designed to be for shorter terms of 1, 3, and sometimes 5 years. This is by design based on the average lifespan of venture-backed startups. After 5 years, it’s worth going through the full underwriting process of traditional key person insurance.
Underwriting	Full underwriting: blood, urine, possible EKG, retrieving doctor records, and possible third party inspection. The process usually takes 4-6 weeks but can take longer due to scheduling conflicts.	No medical exams, no doctor visits and no financial history requests. The policy can be bound within a day or two of receipt of payment. A 5-minute questionnaire is all it takes to get a quote. This is designed to be a frictionless product tailored for VCs and startup companies.
Carrier Quality	Will always come from US “admitted” carriers (when placed by Founder Shield), meaning that the insurance companies are subject to additional state laws and regulations. In theory, these policies are safer because a state fund will pay out claims if the carrier goes bankrupt, and policyholders have more recourse for filing complaints with the state.	This policy is “non-admitted,” which means that the carrier did not have to jump through any extra hoops to get the blessing (and backing) of the states in which the policy is offered. It’s backed by Lloyd’s of London, one of the most experienced, respected, and financially sound A+ carriers in the world.
Limits	More stringent guidelines can make obtaining the limit you want challenging. Insurance carriers will consider the company's value and revenue when underwriting, which can be problematic for some venture-backed startups that are pre-revenue or just getting going.	Flexibility in the limits available to policyholders. On a case-by-case basis, the carrier can offer policies with limits of up to $20M
Claim Payments	The policy will provide a lump-sum payment to the beneficiaries listed on the policy. The underwriting was done prior to the policy being bound.	The policy will pay the net ascertained loss to the policyholder following the death of the key person. Underwriting is done at the time of the loss to determine its full extent.

3 Reasons Late-Stage Companies Need This Coverage

New businesses, VC-backed startups, and entrepreneurs are well-known for being the first in line to purchase key person or contract frustration insurance. However, late-stage companies aren’t exempt from financial hardships when a key member of their team passes away or faces disability. Here are three reasons why this coverage is vital for high-growth companies.

1. Business operations would halt without the key person.

Consider how your professional performance would unfold if you lost a key person. Perhaps your key person is a seasoned executive with seemingly endless industry knowledge. Or maybe it’s a salesperson who drives your entire sales force. What kind of hit will your revenue take if you lose this person? Besides revenue, how will your team carry on, and how will you replace key employees? Insurance coverage can help get your company back on track as you navigate such a loss.

2. Future financing is needed for ongoing growth.

High-growth companies have often gone through many funding rounds (i.e., private equity, Series A, Series B, etc.). The end game is often a successful exit, such as an initial public offering (IPO). However, most investors and lending institutions require companies to carry several policies, such as D&O insurance and key person insurance, before investing in them. Ensuring ongoing growth means having such vital coverage in place.

3. A business continuity plan faces scrutiny without coverage.

Establishing a plan B (and beyond) ensures that a business continues forward. Let’s face it; even the most well-thought-out plans can go wrong. Losing a key member can impact a business’s continuity significantly. Consider who will take over their role, another member, a spouse, or a new hire? Should a tragedy occur, key member or contract frustration insurance can keep the company moving forward with little hassle.

Understanding the details of what coverage your company needs can be a confusing process. Founder Shield specializes in knowing the risks your industry faces to make sure you have adequate protection. Feel free to reach out to us, and we’ll walk you through the process of finding the right policy for you.

Want to know more about key person insurance? Talk to us! Please contact us at info@foundershield.com or create an account here to get started on a quote.