How it works
A key person calculation asks an owner the question boards ask public companies: if one specific human disappeared tomorrow, what would it actually cost the business? The damage arrives in four waves, and the calculator prices each. First, the profit vacuum — the gross profit this person directly drives, multiplied across however many months a credible replacement search realistically takes, which for specialized roles runs twelve months or more. Second, client flight: revenue concentrated in accounts that trusted the person rather than the letterhead, times your honest estimate of what walks. Third, the hard cost of recruiting, signing and training a successor. Fourth, the financing tripwire lenders rarely advertise until it trips — business loans carrying personal guarantees or continuation clauses can accelerate when a named key contributor exits. Summing the waves yields the coverage target, rounded to the next fifty-thousand-dollar increment because that is how carriers quote. Structurally, the business owns the policy, pays the premium, and collects as beneficiary, turning an existential personnel event into a funded transition instead of a fire sale. For family firms the analysis carries extra weight: the founder is often simultaneously the largest asset and the least replaceable one, and siblings arguing through a crisis without liquidity is the failure mode nobody plans. Pricing depends on age, role and underwriting; the sizing logic is universal.
Formula
coverage = profit x (disruption months / 12) + key revenue x (1 - retention %) + hire cost + callable debt
Tips
- Be brutal about the retention percentage — clients loyal to a person rarely stay loyal to a logo.
- Lengthen the disruption window for licensed or technical roles; recruiters charge for speed either way.
- Read your loan covenants tonight: continuation clauses triggered by one departure are common and silent.
- Pair key person cover with a buy-sell agreement when multiple owners exist — they solve different failures.
- Re-underwrite the policy after every major role change; coverage sized for yesterday's org chart underprotects today's.
Frequently asked questions
- How much key person insurance does a small business need?
- Enough to bridge the profit gap during a realistic replacement search, absorb expected client attrition, fund the hire, and neutralize any debt the departure accelerates. On typical small-firm inputs that lands between two hundred fifty thousand and one million dollars — the calculator builds the figure from your own operating numbers rather than a salary multiple.
- Who owns and pays for key person insurance?
- The business owns the policy, pays the premiums and is named beneficiary. If the insured person departs or dies, proceeds fund the transition — search costs, bridged profits, debt payoff. Premiums are generally not tax-deductible, but proceeds arrive generally free of income tax when the death benefit pays.
- Is key person insurance the same as buy-sell coverage?
- No. Key person cover compensates the business for losing an employee's contribution; buy-sell funding transfers ownership from a deceased or exiting owner to the survivors. Closely held family firms frequently need both, because losing a founder-as-worker and losing a founder-as-owner are distinct catastrophes with separate price tags.
- Can key person insurance cover disability, not just death?
- Often yes, via riders or stand-alone key person disability policies, and arguably disability matters more — a long absence costs the firm without triggering any death benefit. Coverage definitions and waiting periods vary significantly by carrier, so price the disability extension explicitly rather than assuming the base policy addresses it.
- What happens to the policy if the key person retires normally?
- The business can surrender it for accumulated cash value, maintain it as deferred compensation for the individual, or exchange ownership. Term-based key person cover simply lapses. Decide the exit treatment before purchase, because an unowned legacy policy drifting on the books is a common audit finding.