Buy-Sell Insurance vs Key Person Insurance: Which Does Your Business Need?

Covermate Life
Sep 21
4 min read

When it comes to protecting your business, there are a lot of insurance options. Two of the most important for business owners are Buy-Sell Insurance and Key Person Insurance.

At Covermate Life, we often see business owners confused about the difference between the two — and which one they actually need.

This guide will give you a complete overview, including use cases, benefits, costs, and common mistakes, so you can make informed decisions for your business.

What is Buy-Sell Insurance?

Buy-Sell Insurance (sometimes called Shareholders’ Agreement funding) is designed to protect ownership continuity in a business. It works in conjunction with a legally binding buy-sell agreement, which specifies how shares or ownership interests are transferred if a shareholder or partner dies, becomes disabled, or suffers a serious illness.

Key points:

It provides funding to buy out a departing owner.
Protects remaining partners or shareholders from disputes or unwanted ownership changes.
Common triggers include death, total permanent disability (TPD), or critical illness.

Example scenario:

Two partners, Alice and Ben, co-own a company. Alice passes away unexpectedly. Without a funded buy-sell agreement, Ben may struggle to buy out Alice’s share from her estate. Buy-Sell Insurance provides the cash needed to transfer ownership smoothly, protecting both the business and Alice’s family.

What is Key Person Insurance?

Key Person Insurance, on the other hand, protects the business itself from financial loss caused by the death or incapacity of a key individual — usually someone essential to revenue, operations, or strategy.

Key points:

It provides a lump sum to the business, not the owners personally.
Covers losses such as lost profits, recruitment costs, and business continuity expenses.
Often used for founders, CEOs, or highly skilled employees.

Example scenario:

If Ben, the technical lead and co-founder, suddenly becomes disabled, Key Person Insurance could provide funds to hire a replacement, pay creditors, or cover lost revenue during the transition.

Buy-Sell Insurance vs Key Person Insurance: Key Differences

Feature	Buy-Sell Insurance	Key Person Insurance
Purpose	Facilitate ownership transfer	Protect the business from financial loss
Beneficiary	Surviving owners or co-owners	The business
Trigger Event	Death, TPD, critical illness of owner	Death, TPD, critical illness of key person
Use of Funds	Fund buy-out of departing owner	Cover lost profits, recruitment, or operational costs
Legal Requirement	Must be part of a buy-sell agreement	Not legally required, optional for business continuity
Typical Users	Co-owned businesses, family businesses, partnerships	Businesses heavily reliant on one or more key individuals

When to Use Buy-Sell Insurance

Buy-Sell Insurance is generally recommended when:

Your business has two or more owners.
You want certainty in ownership transfer if someone leaves, dies, or becomes disabled.
You want to protect co-owners from personal financial exposure.
Your business is a family business or professional practice (medical, legal, accounting).

Key benefits:

Smooth ownership transfer without legal disputes.
Fair compensation for departing owners or their estate.
Maintains control of the business in the hands of intended owners.

When to Use Key Person Insurance

Key Person Insurance is appropriate when:

Your business is heavily dependent on one or more individuals.
Losing a key individual would result in financial loss or operational disruption.
You want to protect revenue, credit lines, or client relationships in case of incapacity or death.

Key benefits:

Provides immediate funding to cover lost profits or expenses.
Allows time to recruit or train a replacement.
Supports business continuity and creditworthiness.

Can You Have Both?

Yes — and many businesses do.

A growing trend is for co-owned businesses with key personnel to have both policies in place. Buy-Sell Insurance ensures ownership remains stable, while Key Person Insurance protects the business financially if critical staff are lost.

Example scenario:

Alice and Ben co-own a business. Alice is also the sales lead. They have:

Buy-Sell Insurance to ensure Ben can buy Alice’s share if she dies.
Key Person Insurance to cover lost revenue if Alice can’t work due to illness.

This combination provides comprehensive protection for both ownership and business operations.

Costs and Considerations

The cost of either insurance depends on several factors:

Age, health, and occupation of insured individuals.
Coverage amount / sum insured.
Type of policy (life only vs life + TPD vs life + trauma).
Ownership and policy structure (self-owned, cross-owned, business-owned).

Important considerations:

Review and update buy-sell agreements regularly to reflect changes in ownership or valuation.
Ensure policy triggers match your agreement (e.g., critical illness definitions, TPD definitions).
Consider tax implications, particularly for business-owned policies.

Common Mistakes to Avoid

Having a buy-sell agreement without funding.
Confusing beneficiaries: Buy-Sell funds go to owners, Key Person funds go to the business.
Using outdated valuations for Buy-Sell Insurance.
Failing to review coverage annually.
Overlooking tax and legal advice when structuring policies.

Frequently Asked Questions (FAQs)

Do I need Buy-Sell or Key Person Insurance first? It depends on your business structure. If you have multiple owners, Buy-Sell is usually critical. If your business relies on key personnel for revenue, consider Key Person Insurance. Many businesses use both.

Can I insure multiple key people under one policy? Yes. Key Person Insurance can cover several individuals, but each will have a separate insured sum.

Does Buy-Sell Insurance pay out to the business or individuals? Typically, the payout is used by surviving owners to buy out the departing owner’s share. It doesn’t go directly to the business unless the agreement specifies.

Can I change the sum insured after the policy is set up? Yes, most policies allow adjustments, but premiums may change depending on age, health, and coverage.

Are these policies tax-deductible? Business-owned Key Person premiums may be deductible in certain circumstances. Buy-Sell premiums are generally not deductible if they fund ownership transfers. Always confirm with your accountant.