When drafting Shareholders Agreements with clients, we often explore whether the corporation should consider taking out Key Person Insurance or whether we should create a requirement to obtain this type of insurance in the Shareholders Agreement.
Essentially, the purpose of Key Person Insurance is to create an insurance payout on the occurrence of the death or disability of a key person in the business. The reasons for wanting this type of payout can be as follows:
- Shareholders Agreement creates a triggering event such that upon the death or disability of the key person, the corporation (or other founder(s)) can buy out that key person. Funds are used for the buy-out.
- Funds are used to recruit, hire and train a replacement to the key person.
- Funds are used to pay off debt and deal with creditors.
- Funds are used as a reserve against a potential loss in revenue while the company goes through transition.