What role does key person insurance play in business valuation and sales?

Key person insurance plays a significant but complex role in business valuation and sale processes in Australia. From a risk perspective, having key person insurance in place demonstrates sophisticated business risk management to potential buyers and can positively influence business valuation by showing the business has protected itself against key person dependency. Buyers view this favourably as it indicates lower risk and better governance. However, key person insurance also highlights key person dependency risk - if a business requires substantial insurance on specific individuals, it signals concentration risk that may concern buyers and potentially decrease valuation. Sophisticated buyers will assess whether the business can operate successfully without these key persons. During due diligence, buyers examine key person insurance arrangements to understand business dependencies, assess how critical certain individuals are to operations and revenue, evaluate succession planning adequacy, and determine whether insurance coverage is appropriate for the identified risks. The policies themselves typically don't transfer to buyers - key person insurance is specific to the current business entity and key persons. Upon business sale, existing policies are usually cancelled as the previous owners' key person dependencies are no longer relevant. New owners may establish their own key person insurance on individuals they identify as critical. From a transition perspective, key person insurance can provide financial protection during earnout periods or if the selling owner remains temporarily post-sale and subsequently becomes unable to fulfill transition obligations. For business succession within families or management buyouts, existing key person insurance may continue or be restructured to support the new ownership structure while protecting against transition risks.