In a small business, the death of the owner or another key individual might result in short-term financial distress. Unless the company has enough cash to buy out the deceased person's shares, the remaining partners or beneficiaries could be forced to sell the business to an outside party that may or may not act in the best interests of the employees and other stakeholders.
The death benefit from key person insurance can provide a vital source of cash that these parties can use to find a replacement or carry out other succession decisions. Even in cases where the business's long-term viability looks doubtful, the money can help the business wind down operations by paying off outstanding debts, providing severance pay for employees and addressing any other financial obligations.
If the business is highly dependent on a certain person or people, some banks require having such a policy in place before providing a loan. As such, key person insurance can be valuable even if the individual ends up outliving the term of a policy.
Not every small business needs this coverage. Key person insurance can be critical for the long-term success of small businesses with multiple employees. But it may not be necessary for a sole proprietorship where the owner intends the business to wind down after they pass away. Although if that solely owned business has significant outstanding debts that beneficiaries will need to pay, key person insurance could be useful then, too.
