SBA Loans and “Key Man” Life Insurance

The SBA requires lenders to require many borrowers to carry some amount of life insurance as a condition of receiving financing.  This is because most of the time a small business has one or a few “key” people whom the business might not survive without.

How much insurance is required?

The SBA states it this way:

“The amount of life insurance required must be consistent with the size and term of the loan. The amount and type of collateral available to repay the loan may be factored into the determination of the appropriate amount of life insurance.”

Is life insurance an absolute requirement for financing?

Actually, no.

SBA states that:

“the lender must require life insurance unless the lender determines due to the adequacy of collateral and/or the presence of secondary sources of repayment that life insurance is not necessary.”

Essentially this means that if there isn’t a really strong succession plan and/or a secondary source of repayment then the lender will have to make sure the borrower has enough life insurance to pay off the loan after liquidation of whatever collateral the business has.  (The lender may accept the pledge of an existing life insurance policy).

The lender must also make sure the borrower keeps the policy current by monitoring policy premiums and they may set up an escrow account for this purpose.

When a new policy is required, the SBA recommends a decreasing term policy and not credit life or whole life.

The key takeaway is that there is no hard and fast rule re: how much insurance a lender needs to have on a borrower because the SBA language is kind of gray and every loan is unique, but many lenders will err on the side of caution as they do not want to jeopardize the loan guarantee they get from SBA.

So if the survival of a business depends on the active participation/day to day performance of any key people and the loan amount exceeds the available collateral then you will most likely need some amount of life insurance.

More information about SBA loans: Green Commercial Capital