A discount to the value of the business is sometimes made when a 'key man' or key individual is responsible for the material well-being of the company. The loss of this key person would have a disastrous effect, and the valuation of the business must reflect this risk.
A key person has secure relationships with customers, vendors and employees; has access to economically helpful resources like banks and potential investors; may have intellectual collateral that advances the company's prospects; possesses general and particular experience related to the industry and the company's niche; and may have management abilities that synthesizes all these attributes into a nearly indispensable role.
When a professional valuator considers the influence of a key person on the performance capabilities of the company, a variety of considerations will be analyzed. Among these details are:
- The types of services performed by the key person
- The degree of dependence the company has placed on this person
- The likelihood of the key person leaving through retirement, death, or the voluntary pursuit of new ventures
- The impact this departure would have on profitability
- The ability of the remaining executives to assume the vacant roles and perform at equivalent levels to the key person
- The existence of a succession plan and the probability of securing an adequate replacement, either from within the company or from outside
- The compensation cost for hiring more than one manager to replace the key person
- The loss of key relationships that were available only because of the unique connection to the key person
- The loss of the company's reputation, which was built in part on the presence of the key person
- The loss of business during the interim in which a new executive becomes proficient with the business of the company.
All these influences will be measured, and a discount will be applied to the company's value because of the risk entailed with the loss of the key person.
A valuation expert has additional means to offset the loss of a key person as well. Some of these are the existence of a non-compete agreement that protects the company from a departed key person using his or her knowledge and abilities against the company in the marketplace; insurance policies that protect the company financially in case of death or disability of the key individual; and perhaps a saving on the compensation to the new executive in comparison to the former.
The key man discount can be considered either in the cost of capital, which is in the company-specific risk calculations of the analysis, or it can be taken from the concluded value, but this discount cannot be applied in both locations of the analysis, only one.
To understand how this impacts you and your business, contact your financial advisor or a business attorney.
To learn more about how a "key man" impacts the value of your business, consult the financial experts at Synergetic Finance or consult author Joseph M. Maas' book "Exit Insight: Getting to Sold!" available through Merrell Publishing