Do lenders require key person insurance for a business purchase loan?

Lenders decide their conditions case by case, so there is no single answer across Canada. Whether a lender asks for key person insurance turns on how much of the business’s income rests on one or two people, and who those people are after the purchase. This page is about how lenders respond to that exposure. For the exposure itself, see what key person risk is.

Why a lender looks at the people

A purchase loan is repaid from the business’s future earnings. Treadstone Associates says owner-dependence is the first thing a buyer, lender or successor tests for, usually before the numbers are discussed in detail. If customer relationships, pricing or vendor decisions sit with one person and there is no second-in-command, the lender has a reason to ask what happens to repayment if that person dies or cannot work.

What the federal loan program says

The Canada Small Business Financing Program makes loans easier to get by sharing risk with lenders. Its guidelines list life and disability insurance premiums among the costs a lender may charge a borrower, with two limits. A premium expressed as a percentage of the loan must be shown clearly and separately in the loan document, and premiums cannot be capitalized and added to the loan. On this point the guidelines deal with how a premium is charged, not with whether cover must be required.

Reducing the concern before you apply

The same source says the businesses that test well started reducing owner-dependence years before any sale. A lender looking at your file will see the result.

• Document the decisions and relationships that currently live in one person’s head.
• Show a second-in-command who could run the business during an absence.
• Ask the lender early whether it wants cover, on whom, and who would own and pay for the policy.
• Get a quote early, because cost and approval depend on the person insured.