New Zealanders would vote for an alternative flag regardless of whether they supported a change from the status quo or not.
In the second referendum, the public would vote whether to change to the winning alternative design or to keep the current flag.
The second vote could be held in April 2016, Mr Key had been advised.
His office had written to all parties to advise them of the process.
He said the two-stage process would guarantee there was a 50 per cent mandate for the New Zealand flag.
The Prime Minister made the comments after speaking at a conference for the Returned Services Association, which opposed a flag change on the grounds that soldiers fought and died under the current flag.
RSA head Don McIver told Mr Key that the current flag "deserved to be called more than a relic".
Mr Key noted that New Zealand soldiers' graves in Europe had silver ferns carved into them, not the Union Jack and four stars.
"When people say New Zealanders were buried under that flag, that's technically correct when the flag was on the coffin but it's not true in terms of the flag being on their headstones."
Mr Key originally supported a silver fern on a black background, but said his preferences were changing.
His change of preference was not because of the black design's similarity with the flag of the extremist Muslim group the Islamic State.
He still wanted a silver fern, because it was an internationally-recognised symbol of New Zealand's identity, but he did not believe New Zealanders would want a black flag.
