the Key Person Insurance Guide for Startup Founders

✍️ Guidance:

Why investors now demand Key Person cover. A guide for startup lawyers and accountants to share with their high-growth clients.

In the high-stakes world of startups, success hinges on a few indispensable individuals. The visionary founder, the genius coder, the rainmaker salesperson — these are the human assets upon which valuations are built and futures depend. For years, investors implicitly understood this "key person risk." Today, they are no longer just understanding it; they are contractually mitigating it.

The investment landscape of 2026 is defined by rigorous due diligence. Venture capital (VC) funds, angel investors, and even seed-stage backers now scrutinise every facet of a startup's operational resilience. The most significant, uninsurable risk has always been the team itself. But what if it could be insured?

This is why Key Person Insurance has transitioned from a boardroom "nice-to-have" to a non-negotiable clause in the term sheet. For many VCs, seeing a robust Key Person policy in place is as fundamental as reviewing the cap table or IP assignments. It's a clear signal that the founders are commercially astute, thinking not just about growth, but about survival.

This guide is designed for startup founders and the professional advisers who guide them—lawyers, accountants, and consultants. It provides a definitive overview of Key Person Insurance, explaining why it's now essential for securing funding and how to implement it correctly to protect your company's future.

What is Key Person Insurance? A Plain English Definition

Key Person Insurance is a business protection policy designed to safeguard a company against the financial fallout from losing an indispensable member of staff to death or serious illness.

Think of it as life and critical illness cover for the business, on the business's most important people.

Here’s the simple breakdown:

• Who owns it? The startup or business owns the policy.
• Who pays for it? The business pays the monthly or annual premiums.
• Who is insured? A 'key person'—an individual whose loss would have a severe financial impact on the company.
• Who gets the money? If a claim is made, the cash lump sum is paid directly to the business.

The purpose of this payout is to provide a crucial cash injection, allowing the company to manage the disruption, reassure investors, and implement a recovery plan without facing immediate financial collapse.

How Does Key Person Insurance Actually Work?

The mechanics of Key Person Insurance are straightforward. The process is a logical sequence of steps designed to create a financial safety net for your organisation.

The 5-Step Process:

1. Identification: The company's directors identify the key individuals whose death or long-term illness would critically endanger the business's operations or financial stability.
2. Valuation: The business determines the financial value of each key person and decides on an appropriate level of cover. This is a crucial step where expert advice is invaluable.
3. Application: The company applies for a Key Person policy on the life of the individual. The key person must consent and provide details on their health and lifestyle.
4. Payment: The company pays the insurance premiums. These are typically paid monthly or annually via direct debit from the business bank account.
5. Payout: If the insured person dies or is diagnosed with a critical illness covered by the policy during the term, the insurer pays the pre-agreed lump sum directly to the company, tax-free in most scenarios. The funds can then be used as the business sees fit to navigate the crisis.

This injection of capital buys the business what it needs most in a crisis: time and options.

Identifying the 'Key Person' in Your Startup

In an early-stage company, it often feels like everyone is a key person. However, for insurance purposes, the definition is more specific. You must identify the individuals whose loss would cause a direct and significant financial impact.

It's not always the CEO. Ask yourself these questions about your team members:

• Whose death or illness would cause an immediate drop in revenue or halt product development?
• Who possesses unique technical skills, intellectual property, or knowledge that is core to our product?
• Who holds the critical relationships with our investors, major clients, or strategic partners?
• Whose absence would make it significantly harder to raise our next round of funding?
• Who has personally guaranteed business loans that would need to be repaid?

Common Key People in a Startup:

• The Visionary Founder/CEO: The strategic leader, primary fundraiser, and public face of the company. Their loss can shatter market and investor confidence.
• The Technical Co-Founder/CTO: The architect of the technology. In many tech startups, the entire value proposition is built on their expertise. They are often genuinely irreplaceable in the short to medium term.
• The Head of Sales/Growth: The individual directly responsible for generating the majority of the company's revenue.
• The Lead Scientist/Researcher: In deep tech, biotech, or pharmaceutical startups, this person's knowledge is the company's primary asset.

Identifying these individuals is the first, most critical step in de-risking your human capital.

Calculating the Right Level of Cover: The Adviser's Formula

Determining the "sum assured" (the amount of cover) is more of an art than a science, but it must be based on a logical financial assessment. Insurers will want to see your justification for the figure you choose. An arbitrary number plucked from the air won't suffice.

Here are the most common methods used to calculate an appropriate level of Key Person cover. Often, a blend of these approaches provides the most realistic figure.

A Practical Example: "Cost of Replacement" for a CTO

Let's say your CTO, a key person, is on a founder's salary of £60,000. Their market value is closer to £150,000. (illustrative estimate)

• Headhunter Fees (illustrative): 25% of a £150k salary = £37,500
• Temporary Cover (illustrative): Hiring an interim CTO (contractor) for 6 months @ £1,000/day = £120,000
• Lost Revenue/Delays: Estimated impact on product roadmap and sales = £250,000
• Higher Salary for Replacement (illustrative): The new hire won't have founder equity, demanding a higher cash salary. Let's budget for this over 3 years = £90,000 x 3 = £270,000
• Total Estimated Impact: £677,500

In this scenario, a Key Person policy for between £500,000 and £750,000 would be a justifiable and prudent amount of cover. At WeCovr, our advisers specialise in helping startups work through these calculations to arrive at a figure that is both meaningful and affordable.

Key Person Insurance vs. Other Business Protection: A Clear Comparison

The world of business protection has several specialised products. It's vital to understand the differences, as choosing the wrong one can be a costly mistake. Key Person cover protects the business, whereas other policies are designed to protect shareholders or employees' families.

Here is a clear comparison of the main types of business protection insurance:

| Feature | Key Person Insurance | Shareholder Protection | Relevant Life Policy | Executive Income Protection | | :--- | :--- | :--- | :--- | | Primary Purpose | Provides a cash lump sum to the business to help it recover from the loss of a key individual. | Provides a lump sum to the surviving shareholders to buy the deceased/critically ill shareholder's equity. | Provides a tax-efficient death-in-service benefit for an employee, paid to their family/estate. | Provides a replacement monthly income to an employee (paid via the business) if they are unable to work. | | Who Owns the Policy? | The business. | Typically, the individual shareholders or the business (held in a business trust). | The business. | The business. | | Who is the Beneficiary? | The business. | The other shareholders or a trust. | The employee's family or a trust. | The employee (income is channelled through the business's payroll). | | Main Benefit | A cash buffer to ensure business survival and continuity. Protects company value. | Ensures a smooth transfer of ownership and provides liquidity for the deceased's family. Protects the existing shareholders' control. | A valuable employee benefit, equivalent to a personal life insurance policy but paid for by the company tax-efficiently. | Protects an individual's earnings and allows the business to support a valuable employee without draining its own resources. |

Each of these policies solves a different problem. A comprehensive business protection strategy for a mature startup may involve all of them. However, for an early-stage, investor-backed company, Key Person Insurance is the foundational layer.

The Two Core Components: Life Insurance and Critical Illness Cover

A Key Person policy is not a single, rigid product. It is typically built from two primary components, which can be taken separately or combined.

1. Life Insurance Component

This is the most fundamental part of the cover.

• How it works: It pays out the agreed lump sum if the key person dies during the policy term.
• Type of policy: This is almost always a Level Term Assurance policy. This means the amount of cover remains fixed for a set number of years (the "term"), for example, 5, 10, or 15 years.
• Why it's essential: It provides the capital to manage the immediate chaos following the death of a founder or key employee—hiring replacements, reassuring investors, and servicing debt.

2. Critical Illness Component

This component is arguably even more important for a startup. Statistically, a key person is far more likely to suffer a serious illness than to die before retirement.

• How it works: It pays out the same lump sum if the key person is diagnosed with one of the specific serious medical conditions defined in the policy.
• Why it's crucial: The long-term absence of a key person due to illness can be more financially damaging than their death. The business not only loses their contribution but may still be morally or contractually obliged to pay their salary. The critical illness payout provides the funds to hire a temporary or permanent replacement while the key person focuses on their recovery.
• What it covers: All policies cover the "big three" — cancer, heart attack, and stroke — which account for the vast majority of claims. However, comprehensive plans from major UK insurers can cover over 50 specified conditions, including multiple sclerosis, motor neurone disease, and major organ transplant.

Adviser Insight: Combining Life and Critical Illness cover provides the most comprehensive protection. The policy will pay out once, on either diagnosis of a qualifying critical illness or on death, whichever happens first. This structure is the one most commonly demanded by VC investors.

Real-Life Scenario: How Key Person Cover Saved a Fintech Startup

To understand the real-world power of this cover, consider this scenario based on cases we've seen.

The Startup: "ConnectWealth," a promising UK fintech platform, is two years old. The three co-founders have just successfully closed a £2.5 million Series A funding round. (illustrative estimate)

The Key Person: Sarah, the 38-year-old Chief Technology Officer. She is the architect of their unique AI-driven analytics engine, the company's core intellectual property.

The Investor's Condition: As part of the funding term sheet, the lead VC investor insisted on a £1.5 million Key Person policy covering Sarah's life and critical illness. They saw her as a single point of failure. The co-founders, guided by their adviser, put the policy in place. (illustrative estimate)

The Event: Nine months later, Sarah is diagnosed with an aggressive form of cancer. The prognosis is good, but the treatment will require at least 12-18 months away from her high-pressure role.

The Payout: After the diagnosis was confirmed, the insurance company paid the £1.5 million claim benefit directly to ConnectWealth's business bank account. (illustrative estimate)

How the Business Used the Funds:

• £180,000 (illustrative): To immediately hire a highly-skilled interim CTO from a specialist consultancy to keep development on track.
• £250,000 (illustrative): To recruit and secure a top-tier permanent replacement. This included significant headhunter fees and a competitive salary package to attract the right talent.
• £500,000 (illustrative): To accelerate the development of a secondary product stream, diversifying the company's risk.
• £570,000: Held in reserve to extend the company's cash runway, reassuring the board and investors that the business was stable despite Sarah's absence. This prevented a panic situation or a potential fire sale.

The Outcome: ConnectWealth navigated a potentially company-ending event. They maintained their development velocity, kept their investors confident, and continued on their growth trajectory. Sarah was able to focus entirely on her health without the pressure of the company collapsing. Without the Key Person policy, the business would almost certainly have failed within six months.

Tax Implications of Key Person Insurance: A Guide for Accountants

The tax treatment of Key Person Insurance is a critical area where professional advice is essential. The position taken by HM Revenue & Customs (HMRC) depends on the purpose of the policy.

The framework for this is based on a historic tax case known as BIM45525 (Anderson).

Tax Treatment of Premiums

Are the premiums a tax-deductible business expense?

The answer is, "it depends."

• Generally YES, if... the policy's sole purpose is to cover the loss of business profits that would result from the key person's death or illness. The policy must be a short-term plan (typically ending before the person's retirement age) and have no investment element or surrender value.
• Generally NO, if... the policy is designed to cover a capital-related purpose. This includes policies intended to repay a loan (like a Director's Loan or a bank loan) or to facilitate the purchase of shares from a director.

Tax Treatment of the Payout (Claim Benefit)

Is the lump sum payout taxable?

This follows a logical principle tied to the treatment of the premiums.

• If the premiums WERE allowed as a tax deduction... the payout is likely to be treated as a trading receipt and will therefore be subject to Corporation Tax.
• If the premiums were NOT allowed as a tax deduction... the payout is likely to be treated as a capital receipt and will therefore be tax-free.

Summary of Tax Treatment

Crucial Adviser Note: The structure and intended purpose of the policy must be decided before the policy starts. You cannot change your mind later. It is vital for the business directors, their accountant, and their protection adviser to discuss this to ensure the policy is set up in the most appropriate and tax-efficient way for its intended goal.

Navigating the Application Process: Underwriting for Founders

Once you've decided on the cover, the next step is the application and underwriting process. "Underwriting" is the insurer's risk assessment of the individual being insured. For busy founders, this can seem like a daunting process, but a good adviser can streamline it.

What Insurers Assess:

• Age, Smoker/Vaper Status: These are the biggest factors affecting price.
• Health & Medical History: You'll complete a detailed health questionnaire. For large cover amounts, the insurer may request a nurse screening or a report from your GP.
• Lifestyle: This includes alcohol consumption, participation in hazardous sports (e.g., mountaineering, motorsports), and travel to high-risk locations.
• Financials: The insurer will need to see the financial justification for the level of cover requested.

Challenges Specific to Startup Founders:

• High-Stress Environment: Insurers are aware of the pressures of startup life.
• Long Working Hours: This can be a factor in health assessments.
• Extensive International Travel: Frequent travel, especially to certain countries, may need to be declared.

Full and honest disclosure is paramount. Any non-disclosure could invalidate the policy at the point of claim.

The WeCovr Advantage: As independent brokers, we have deep experience with the underwriting appetites of all major UK insurers. We know which providers take a more pragmatic and understanding view of the modern founder's lifestyle. We can pre-empt potential issues and place your application with the insurer most likely to offer the best terms quickly, without unnecessary premium increases or exclusions. As part of our commitment to our clients' wellbeing, we also provide complimentary access to CalorieHero, our AI-powered nutrition and calorie tracking app, to help you manage your health amidst a busy schedule.

What About Other Key People? Executive Income Protection for Your Senior Team

While founders are often the first priority, as your startup grows, your reliance on other senior hires increases. Your Head of Engineering, VP of Sales, or Head of Product become critical to your success. Losing them to a long-term illness for a year or more could be devastating.

This is where Executive Income Protection comes in.

What is it? An insurance policy, owned and paid for by the company, that provides a replacement monthly income for an employee if they are unable to work due to illness or injury.

How it Works:

1. The company pays the premium, which is almost always an allowable business expense.
2. The employee is signed off work long-term.
3. After a pre-agreed "deferred period" (e.g., 13, 26, or 52 weeks), the insurer starts paying a monthly benefit.
4. This benefit is paid to the company.
5. The company then pays this money to the employee through the normal PAYE payroll system, where it is treated as salary.

Why It's a Powerful Tool for Startups:

• Attract & Retain Talent: It's a highly-valued benefit that demonstrates you care for your senior team, helping you compete with larger corporations for top talent.
• Protects the Business: It removes the financial and emotional burden of deciding how long you can afford to keep paying a key employee who isn't working. The policy takes on that responsibility.
• Cost-Effective: It is significantly more tax-efficient than giving an employee a pay rise to fund their own personal income protection plan.

Advanced Protection Planning for Founders: Shareholder Protection & IHT

As your startup matures and your personal wealth grows, your protection needs evolve. Two advanced areas to consider are Shareholder Protection and Inheritance Tax (IHT) planning.

Shareholder Protection

The Problem: Imagine a startup with three founders, each owning a third of the company. One founder tragically dies. Their shares, now worth a significant amount, pass to their spouse as per their will. The spouse has no interest in the business and wants to liquidate the shares for cash. The two surviving founders don't have the personal funds to buy them out. A new, unknown third party could buy the shares, leading to a loss of control, or the company could be paralysed by deadlock.

The Solution: A Cross-Option Agreement backed by life and critical illness insurance.

• How it works: This is a legal agreement where all shareholders agree that if one of them dies or becomes critically ill, the survivors have the 'option' to buy their shares, and the departing shareholder's estate has the 'option' to sell them. The life/CI policies, often written in trust, provide the exact amount of cash needed for the surviving shareholders to execute the purchase at a pre-agreed valuation.
• The Result: A seamless, fair, and funded transfer of ownership. The surviving founders retain control, and the deceased's family receives the fair market value for their shares in cash.

Gift Inter Vivos (IHT Planning)

For successful founders whose personal estate (including their company shares) is likely to exceed the IHT threshold, planning is key.

• The Scenario: You make a large lifetime gift of cash or shares to your children to reduce the value of your estate. This is a 'Potentially Exempt Transfer' (PET).
• The Risk: If you die within 7 years of making the gift, it fails to become exempt and falls back into your estate for IHT purposes, creating a potential tax bill of up to 40% for the recipients of the gift.
• The Solution: A Gift Inter Vivos policy. This is a special type of 7-year decreasing term life insurance. The cover amount is matched to the potential IHT liability and reduces over the 7 years, in line with the 'taper relief' rules. If you die within the 7-year period, the policy pays out to cover the exact IHT bill, ensuring the gift is received in full.

Common Mistakes Startups Make with Key Person Insurance

Navigating business protection for the first time can be complex. Here are some of the most common and costly mistakes we see startups make.

1. Under-insuring (illustrative): Opting for a token amount of cover, like £50,000, to simply "tick a box." In a crisis, this amount is insufficient to make a real difference and is a waste of money.
2. Ignoring Critical Illness: Only taking out life cover because it's slightly cheaper. The risk of a key person being unable to work for a year is statistically much higher than them dying, and the financial impact is just as severe.
3. "Set and Forget" Mentality (illustrative): Failing to review the cover. The £500,000 policy that was right for your pre-seed company is dangerously inadequate after a £10 million Series B round. Cover should be reviewed annually and after every funding round.
4. Incorrect Ownership: Setting up the policy in the key person's own name, rather than the business's. This means the payout would go to their family, not the business, defeating the entire purpose.
5. The DIY Approach: Trying to buy a policy from a comparison website without advice. This often leads to choosing the wrong product, setting it up with the wrong tax structure, or failing the underwriting process due to incorrect disclosures. Key Person cover is a specialist product that requires specialist advice.

How to Get Started: Your 3-Step Plan

Putting the right protection in place is a sign of a mature, well-managed company and can smooth the path to your next funding round.

Step 1: Identify & Quantify Use the guidance in this article to hold a board meeting. Identify the 1-3 individuals who are truly indispensable to your business right now. Use the "Cost of Replacement" method to estimate the financial impact of their loss and determine a sensible level of cover.

Step 2: Talk to a Specialist Adviser This is not a generic financial product. The structure, tax implications, and justification require expert knowledge. The advisers at WeCovr live and breathe this market. We will walk you through the process, explain the nuances, and then search the entire UK insurance market to find the most suitable and competitive policy for your startup's specific needs.

Step 3: Implement & Review Get the cover in place as soon as possible—ideally well before you are in the final stages of due diligence for a new funding round. Once the policy is active, set a recurring annual calendar reminder to review the level of cover with your adviser to ensure it keeps pace with your company's growth.

Frequently Asked Questions (FAQ)

Protecting your key people is protecting the future of your business. It's a strategic decision that safeguards your operations, secures your funding, and demonstrates to investors that you are building a resilient, long-lasting enterprise.

Ready to de-risk your startup and strengthen your investment case? Contact the business protection specialists at WeCovr today. We'll provide a no-obligation market comparison and expert advice tailored to your company's unique needs.

Sources

• Office for National Statistics (ONS): Mortality and population data.
• Association of British Insurers (ABI): Life and protection market publications.
• MoneyHelper (MaPS): Consumer guidance on life insurance.
• NHS: Health information and screening guidance.