Key person insurance signals to buyers, lenders, and valuers that the business has formal protection against the loss of critical individuals. Existing policies typically do not transfer to new owners. The business sale event itself usually triggers a review of all key person cover. Buyers value risk-management discipline; they also scrutinise dependency risk.
Key person cover does not, on its own, increase the sale price of a business. The discipline it represents (formal recognition of key-person dependency, documented risk transfer, audited policies in place) is a positive signal in due diligence. The dependency it documents (revenue concentration on one or two people) can be a negative signal.
How due-diligence buyers assess key person cover
- Policy inventory: list of all key person policies, with insurer, cover type, sum insured, policy owner, beneficiary, and annual premium.
- Documentation review: application forms, PDS extracts, business resolutions authorising the cover, accountant's letters evidencing purpose.
- Capital-vs-revenue purpose mapping: whether each policy is documented as revenue purpose, capital purpose, or split, and whether the documentation supports the intended ATO treatment.
- Underwriting analysis: any loadings or exclusions on the key persons being insured, which signal underlying medical risk.
- Loan-protection coverage: where the business has loans secured against personal guarantees or business assets, does the key person debt-protection cover match the outstanding loan balance?
- Buy/sell coverage: where the business has multiple owners, is the buy/sell cover properly funded and aligned with the agreement?
What happens to existing policies at sale
Key person policies typically do NOT transfer to new owners. The policy is owned by the previous business entity (company, partnership, or trust), and the previous owners' key-person dependencies are no longer relevant after sale. Common outcomes:
- Cancellation: the policy is cancelled at completion and the previous business pays no further premium. The new owners take out fresh key person cover on individuals they identify as critical.
- Reassignment: in rare cases, the policy can be reassigned to the new business entity, but this requires:
- Insurer agreement (not guaranteed; the underwriting position may have changed).
- Identical Life Insured (the key person continues with the business under the new ownership).
- Confirmation of insurable interest by the new owner.
- Potential change to the documented purpose, with corresponding ATO documentation.
- Personal transfer: where the key person is also a departing owner, the policy may be transferred to the individual personally. State stamp-duty applies to most transfers; tax treatment changes (no longer a business deduction).
Where key person cover supports the sale process
Key person cover can play a role during the sale itself:
- Earnout protection: where the sale price includes an earnout component contingent on the seller's continued involvement, key person cover during the earnout period can fund payment of the earnout if the seller dies or becomes disabled.
- Transition risk: where the seller remains as a transition consultant for 6 to 24 months, key person cover can protect against the seller's inability to complete the transition obligations.
- Buyout funding: where management buyouts or family-succession sales involve staged payment, key person cover on the management team or successor can protect the financing structure.
How lenders assess key person cover at acquisition
Where a buyer is using acquisition finance, the lender will typically require key person cover on the buying team:
- Life cover and TPD cover on each principal of the buying entity, sized to cover the loan balance.
- Cover term aligned with the loan term (or longer).
- The lender named as loss payee or with first-charge security over the policy proceeds.
- Common cover types: Life, TPD, and (less commonly) Critical Illness.
This is no different from key person debt protection for any other business loan. The lender views the cover as security against death-or-disability default during the loan term.
How valuers treat key person dependency
Professional business valuers (using ASIC RG 111 or similar valuation frameworks) explicitly assess key person dependency as a risk discount factor. A business heavily dependent on one or two individuals typically attracts a higher discount rate (lower valuation multiple) than a business with diversified leadership. Key person cover does not directly change this discount, but it provides evidence the business is aware of and managing the dependency.
In practitioner terms:
- Two equal owners with no key person cover and no buy/sell: high dependency, high risk discount.
- Two equal owners with cross-owned key person cover and a documented buy/sell agreement: lower risk discount.
- Multi-leader business with documented succession and key person cover on each leader: still lower risk discount.
ATO and CGT considerations on sale
Where the business is sold and key person cover proceeds are received during the sale process (for example, the seller dies between contract and completion), the tax treatment is governed by ATO TR 2009/2 plus CGT provisions:
- Revenue-purpose proceeds: assessable income to the seller's business.
- Capital-purpose proceeds: typically CGT-exempt under ITAA 1997 s118-37(1)(a) for the original beneficial owner.
- The Small Business CGT concessions in Division 152 of the Income Tax Assessment Act 1997 may apply where the business meets the maximum-net-asset-value test ($6 million) or the small-business-entity test ($2 million aggregated turnover). Eligibility requires specialist tax advice.
Practical recommendation
Where a business sale is contemplated within the next 24 months:
- Inventory all existing key person policies.
- Document the capital-vs-revenue purpose of each, with an accountant's letter dated before any sale negotiation begins.
- Confirm the buy/sell agreement (if any) is aligned with the cover.
- Discuss the disposal strategy (cancellation, reassignment, or personal transfer) with the broker before sale completion.
This is general advice only.