Key Person Considerations
July 1, 2010
Does your business depend on a key person? Whether this person is the company’s founder or a leading salesperson, one important risk to consider in a business valuation is the impact losing him or her will have on cash flow – both revenues and expenses.
Analyzing the Risk
The purpose of a valuation affects the risk analysis. If you are the key person and you are selling the business, try to maximize the sale price by working to increase the likelihood that strategic relationships will transfer to the buyer. A succession plan may have transferred these strategic relationships before an owner or manager’s departure, but an orderly transition period is less likely where there is no plan in place.
How Losing a Key Person Affects a Business
In addition to cash flow, here are some other aspects of a business that may suffer if a key person leaves:
Sales: If one person has the sole working relationship with most major customers, maintaining the sales level after his or her departure may not be possible. Assessing this risk is part of the valuation process. The valuator reviews sales and evaluates whether each relationship could be transferred to someone else, whether the competition can take these sales away and what sales level the company can expect in the future.
Operations: Reviewing vendor relationships can help determine the stability of the company’s gross profits. If only one person knows where to buy raw materials at the best prices or has a unique relationship with the vendor, the gross profit margins may not be sustainable if he or she departs.
Workforce: Employees whose loyalty stems from a relationship with the owner may leave if the business is sold.
Assess the Impact
Evaluating the risk of reliance on a key person is an important consideration in many business valuations. Owners should address this when preparing to sell their businesses. Proper analysis of its impact on value is essential. Please call if you have questions about how the loss of a key person may affect the value of your business or any other aspect of valuation, we would be glad to help.