Four Ways to Manage Key Person Risk

Key person risk is the risk to a business arising from the business’s dependency on a small number of individuals or even one individual. Usually, that individual is the owner. Where that impacts a business, when it is dependent upon one or more individuals in this way, buyers will discount the price that they are willing to pay.

Although empirical studies of publicly traded companies indicate that the impact of key person risk might be to discount value by as much as 10%, the discount can be much greater where small, privately or closely held companies are concerned. In extreme cases, such as sole proprietorships that are service companies, the effective key person discount might be as great as 100%, meaning that the company has no intangible value that isn’t encapsulated in personal goodwill.

(If you’re reading this article, you probably already know you have a key person issue, and you think it is pretty substantial.)

Identifying the key person problem is, of course the first step. But once you identify a key person problem, how do you solve it particularly if you’re the key person? At a high level, you need to think about what would happen to your business if you were trapped on a deserted island. Game out the scenarios and think about how you’d influence the outcome. How do you make yourself less of a key person?

FIRST | Hire, train, and delegate

You’re going to need to spend some money to tackle your key person issue. Hire at least one person to take on the most important responsibilities you have and make them your apprentice(s). Consider offering equity after a suitable period of high performance, as well as including a stay bonus in their employment agreement. This provides additional compensation to that employee if they stay with the buyer for a certain period after a change of control. Hiring someone to reduce your company’s key person exposure is not a place to cheap out. Once these people are hired, invest heavily in their training – not only money, but your time. You’re the expert on the business and you need to make more experts to reduce your key person exposure. And then delegate to let that training become solidified. They will make mistakes – ones that will frustrate the heck out of you, but they won’t put the company at serious risk.

SECOND | Become fanatical about documentation

Most entrepreneurs and executives detest paperwork and data entry. The problem is, however, that is what often creates value. Customers and referral sources should be entered into a customer relationship management program. All business processes should be documented and kept up to date. If you’re not sure if any process should be documented, document it.

THIRD | Become strategic and ditch the tactical

If more than 20% of your day (the larger the business, the lower this threshold becomes) is spent doing work that employees (current or future) could do, you are too tactical and that is hurting the value of the business. You may think that you are helping your business’s value by “doing the job right” but by not offloading that role, you’re hurting it. If there are frequently technical problems only you can solve, consider adding to your technical staff or upgrading it. If you must close most of the big deals for your firm, you need at least one business development executive. If you must deliver services to any but the absolute most prime customers, you need to add delivery staff. If a key supplier will only give you the best deal, it’s time to introduce the supplier to the other people in your firm that supplier will give the best deal to. If the bankers and venture capitalists will only speak with you, it’s time to consider bringing a CFO onboard.

FOURTH | De-brand yourself

Companies that are named after the founder face a value handicap at birth. It makes it quite difficult for a buyer to take that company over and put their own identity on it. If the company is named after you, consider a re-branding. Your messaging and marketing communications should come from the company or, at the very least, multiple individuals in the company, rather than the founder. Get other people to make your marketing videos, even if you have to hire professional actors. Alternative people should host your podcasts. People other than you should be writing the company’s articles, blogs and posts.

While key person risk weakens company value, the good news is that it’s a risk you can take action to manage. Those actions include hiring the right people, formalizing and documenting process, making your role more strategic than tactical, and pushing your personal brand into the background. By managing key person risk, you’ll be able to build value in your company more quickly, make it more resilient and more likely to attract a cash buyer.

Get more clarity with key person risk. Getting more information helps you assess how big of an issue key person risk is. From there, an actionable plan can be developed to address that risk and maximize the value of one of your most important assets.