How to Divide Shares and Set Vesting

Key person insurance is a life insurance policy a business buys on a founder, owner or critical employee. The company owns the policy, pays the premiums and receives the payout if that person dies, so it has cash to cover lost revenue, repay debt, hire a replacement or buy out an owner’s shares. For most startups, it is the cheapest way to make sure the company survives the loss of the person it’s built around.

Here’s the line I keep coming back to: if your company dies when you do, you don’t have a company yet. You have a job with investors. I’ve seen founders spend months on a logo, a pitch deck and a perfect cap table, and zero minutes on the question every serious investor, lender and co-founder is quietly asking: what happens to this business if the person running it is suddenly gone?

If you want the basics in three minutes before we get into the founder-specific stuff, this short explainer from Alliance Group covers how key person coverage works and why business owners use it.

What Is Key Person Insurance?

Strip away the jargon and it’s simple. The business takes out a life insurance policy on someone whose loss would seriously hurt it. That’s usually the founder or CEO, but it can be a technical co-founder who owns the codebase, the rainmaker who brings in most of the revenue or the operator who holds the key client relationships. You’ll also hear it called “key man insurance” or “key employee insurance.” Same product.

Three roles define it:

• Owner: the business.
• Premium payer: the business.
• Beneficiary: the business.

That last point is what separates it from the policy you buy for your family. Key person coverage doesn’t put a cent into your spouse’s account. It puts cash into the company’s account at the exact moment the company is most fragile. Most policies are term life, because founders need protection for a specific risk window (the next 10 to 20 years of building), not a lifelong investment product. Some carriers also offer a key person disability policy, which is a separate contract and worth asking about.

Here’s the uncomfortable truth I tell first-time founders: the more the business depends on you, the more valuable you are and the more exposed everyone else is. Being indispensable feels like a badge. To a lender, it reads like a single point of failure.

Key Person Insurance vs Term Life vs Buy-Sell Life Insurance

These three get mixed up constantly, and the confusion leaves gaps. They solve different problems for different people. Most founders with a co-founder and a family need all three, not one.

If you haven’t sorted the personal side yet, start there. I wrote a whole founder’s guide to term life insurance because I put it off far too long myself. Key person coverage sits on top of that. It doesn’t replace it.

Who Owns the Policy and Who Is the Beneficiary?

The business owns it and the business is the beneficiary. That’s the whole point. If you personally own it, it’s just personal life insurance with a confusing name.

Two founder-specific details matter here. First, the insured person has to know about it and agree in writing before the policy is issued. More on why that’s critical for taxes below. Second, the payout belongs to the company and can be used for anything the business needs: payroll during the transition, a recruiter’s fee for a new CEO, paying down a loan that a bank might otherwise call or giving investors an orderly wind-down instead of a fire sale.

How Much Key Person Insurance Do You Need?

There’s no single formula, but there are three practical ways founders size it, and good advisors often blend them:

1. Compensation multiple. A common rule of thumb is 5 to 10 times the person’s total compensation (salary, bonus, equity value and benefits). It’s simple, and it’s what many carriers will start from.
2. Replacement and runway cost. What would it actually cost to keep the company alive for 12 to 24 months without this person? Recruiting fees, an interim executive, lost deals, delayed product. Add it up honestly.
3. Obligation matching. If you have a bank loan, venture debt or investor terms tied to you, match coverage to what you owe. Some lenders and investors require it as a condition of closing.

For early-stage founders who pay themselves a modest salary, the compensation multiple understates their real value to the business. That’s why you’ll often see $1 million to $3 million of coverage on a seed or Series A founder. Carriers will ask for financials to justify the number, so the amount has to make economic sense. You can’t insure a pre-revenue side project for $20 million.

How Much Does Key Person Insurance Cost?

Less than most founders assume. For a healthy, non-smoking founder in their 30s or early 40s, a 10 to 20 year term policy is often in the range of roughly $500 to $1,000 per year for every $1 million of coverage. Treat that as a ballpark, not a quote. Age, health, the term length, the carrier and the amount all move the price, and permanent coverage costs far more.

I like to frame it against the rest of the budget. Founders will happily pay for software they barely use. Key person coverage is often cheaper than a single seat of software for the whole team, and it’s the only line item that pays out precisely when everything else stops working.

One tax note on cost: when the business is the beneficiary, the premiums are generally not tax-deductible under IRC Section 264. Plan for it as an after-tax expense.

Is the Key Person Insurance Payout Tax-Free?

Usually, yes, but only if you do the paperwork before the policy is issued. This is the part most founder content skips, and it’s the part that can cost you.

Under IRC Section 101(j), death benefits from employer-owned life insurance can become taxable income above the premiums paid unless two things are true. One, the insured falls into a qualifying group, such as a director, a highly compensated employee or someone employed within the 12 months before death. Founders and executives almost always qualify. Two, the employer met the notice and consent rules before issue. That means the person was told in writing that the company intends to insure them and for up to what amount, that the company will be the beneficiary, and they consented in writing.

The business also reports employer-owned policies each year on IRS Form 8925. Ask your carrier for their 101(j) notice and consent form at application, sign it before the policy is issued and keep a copy with your corporate records. It’s a 10-minute task that protects a seven-figure payout.

Buy-Sell Agreement Life Insurance: Cross-Purchase vs Entity-Purchase

If you have a co-founder, key person coverage only solves half the problem. The other half is ownership. If your co-founder dies holding 50% of the company, their equity typically goes to their estate. Now you might be building a business with their spouse, their kids or their estate’s lawyer as your new partner, none of whom signed up for that.

A buy-sell agreement fixes that in advance. It says that if an owner dies (and often if they become disabled, leave or divorce), their shares must be sold, at a pre-agreed price or formula, to the remaining owners or the company. Life insurance is the usual way to fund it, because the company rarely has a few million dollars of spare cash on the worst day of its life.

There are two main structures:

• Cross-purchase: each owner buys a policy on the other owners. When one dies, the survivors receive the payout and buy the shares directly. Survivors generally get a higher cost basis in the shares they buy, which can matter at exit. The catch is complexity: the number of policies grows fast as you add owners (three owners need six policies).
• Entity-purchase (stock redemption): the company owns one policy on each owner and buys back the deceased owner’s shares. It’s simpler to administer, especially with three or more owners. But survivors don’t get the basis step-up, and after the U.S. Supreme Court’s 2024 decision in Connelly v. United States, company-owned proceeds earmarked for a redemption can increase the company’s value for the deceased owner’s estate tax.

Neither one is automatically right. Two co-founders often lean cross-purchase. A larger owner group often uses an entity-purchase or a hybrid structure. This is a conversation for a business attorney and a CPA together, and the agreement and the policies have to match. I’ve seen co-founders buy the insurance and never sign the agreement, which leaves cash with no rules about what it’s for.

How to Set Up Key Person Insurance: 6 Steps

1. Name your key people. Ask: whose sudden absence would cut revenue, stall the product or trigger a loan or investor clause? Usually it’s one to three people.
2. Size the risk. Run the compensation multiple, the 12 to 24 month replacement cost and your debt obligations. Pick a number you can defend with financials.
3. Choose term length. Match it to your realistic risk window, often 10 to 20 years or until a likely exit.
4. Get independent quotes. Use a licensed broker or advisor who can shop several carriers. Expect a medical exam and a request for company financials.
5. Sign the 101(j) notice and consent before issue. Then calendar Form 8925 with your CPA every year.
6. Align your agreements. If you have co-founders, put a funded buy-sell agreement in place, and tell your board and investors what’s covered.

Key person coverage is one layer of a bigger protection stack. Liability, cyber, D&O and property all play a role, and I broke down what business insurance you actually need so you can see where this one fits.

Mistakes I See Founders Make

Waiting until the round closes. The best time to buy is when you’re young, healthy and before anything changes. Insurability isn’t guaranteed later.

Confusing it with personal coverage. A key person policy protects the cap table, not your kids. You need both.

Skipping the consent form. A missed 101(j) notice can turn a tax-free payout into taxable income.

Buying insurance without a buy-sell agreement. Money without rules creates fights. Paper first, then policies.

Never reviewing it. Revisit coverage after every raise, big hire or valuation jump. A $1 million policy on a company that’s now worth $30 million is barely a speed bump.

Building something that outlives your involvement isn’t morbid. It’s what makes a company investable. The founders who think about this early aren’t more pessimistic than everyone else. They just take the business seriously enough to protect it.

This article is educational and isn’t personal financial, tax or legal advice. Talk to a licensed insurance advisor, CPA and business attorney about your situation before you buy coverage or sign a buy-sell agreement.

Frequently Asked Questions

What is key person insurance in simple terms?

It’s life insurance a business buys on a founder or critical employee. The company owns the policy, pays the premiums and receives the payout, so it can cover lost revenue, debt or hiring if that person dies.

Who is the beneficiary of a key person policy?

The business. It owns the policy, pays the premiums and receives the death benefit. The insured person’s family gets nothing from it, which is why founders also need personal term life insurance.

How much key person insurance should a startup founder get?

A common rule of thumb is 5 to 10 times total compensation. Early-stage founders often carry $1 million to $3 million, sized to replacement cost, runway and any loan or investor requirements.

Is key person insurance tax-deductible?

Generally no. When the business is the beneficiary, premiums usually aren’t deductible. The payout is generally tax-free if the IRC 101(j) notice and consent rules were met before the policy was issued.

What is the difference between key person insurance and a buy-sell agreement?

Key person insurance gives the company cash to survive a loss. A buy-sell agreement decides who buys a deceased owner’s shares and at what price. Life insurance is often used to fund the buy-sell.