Key-person life insurance

Definition

A policy on the buyer's life, assigned to the lender as collateral.

Why It Matters

The lending rules make it a requirement in one specific case and leave it to the lender otherwise. Where a 7(a) loan is not fully secured, life insurance is required in the amount of the COLLATERAL SHORTFALL, for a sole proprietor, a single-member LLC, or any business dependent on one owner's active participation. That last clause is most acquisitions of this size. Two things follow that buyers get wrong. The policy is sized to the gap between the loan and the collateral behind it, not to the loan, so more collateral means less insurance. And an existing policy can be pledged: the rules say a lender may accept one, and that credit life and whole life should not be required, so a term policy already in force may do the whole job. Price it while you are still choosing a lender, because a health condition that adds weeks to underwriting costs far less to find before the exclusivity clock is running.

In numbers: A $4M loan secured by $2.6M of collateral has a $1.4M shortfall, so the policy is written for $1.4M and not for the loan; on a 10-year term for a healthy buyer in their thirties that is roughly $15 to $25 a month.