September 24, 2015

When should a startup buy life insurance for its founders?

Life insurance for founders in a startup is going to become an important factor for a company at some point of the lifecycle. If such a company is still considered a bootstrapping startup, it may be a little premature. The question here is when should a startup purchase such things. From a bootstrapping startup perspective, my answer would be ‘when your hand is forced’.

The most common ‘when’ will be when securing a VC round. Quite often there will be a couple of prerequisites to finishing off a deal and getting the cash. Two of these prerequisites often include taking on some form of insurance. One is procuring Directors and Officers coverage, the second is getting key-man coverage on certain people in the company.

A VC or private equity entity will want to see that the company they are investing in will be protected if something were to happen to a key person or people. In many cases this will involve the founders. Founders will typically have particular experience or knowledge that makes then invaluable to the future of a company. VC’s will want to mitigate the risk against the death of such a key person with this type of coverage.

From the standpoint of a company that is not a bootstrapping startup, I would suggest the time frame is ‘when you can afford it’. If your hand isn’t being forced, it will still be important to secure your company against losing a key person as explained. You will also want to secure the company against ownership issues that arise from the death of an owner. This is where a funded buy/sell agreement comes into play. Life insurance is the primary funding mechanism toward this end.

Buy/Sell agreements are a key component to protecting the company and its ownership in the event of a death of a founder, allowing for the seamless transition of ownership should such an event occur. That said, if yours is a startup company with little or no dollar value attached, you don’t really doesn’t need to spend the too many resources here immediately. Once a company gets out of bootstrapping mode, gets some traction and revenue and has the resources to pay for the funding that goes along with a buy/sell, go ahead and do it. This also goes for key-man coverage. If you’re not having your hand forced, wait until you’re ready and then implement such coverage when the company has the resources.

Insurance brokers will almost always tell you that both is a must. Frankly the buy/sell is more of a must in my mind but that doesn’t mean the key-man isn’t important. Just be sure the timing is on your side if you can control such aspects.

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