Key person risk: what it is, how buyers spot it, and what it costs you

Key person risk is what happens when a business cannot operate normally without one particular person. If that person stops turning up, work stalls and decisions queue behind them, and the value of the business falls with it.

Most writing on this treats it as a staffing problem. Your best salesperson, your lead developer, the operations manager who knows where everything is. The advice that follows is about them: insure them, cross-train around them, plan who replaces them.

In an owner-led business the key person is usually the owner. And when it is you, most of that advice stops working. You cannot insure your way out of being the business. You cannot cross-train someone into your relationships. Succession planning assumes there is someone above you doing the planning.

There is also something the staffing framing misses entirely. Owner dependency is what happens when someone is good at their job for long enough. You were the quickest, you knew it best, so everything found its way back to your desk, and over years your team, your clients and even your suppliers were trained to need you specifically. The business got so good at running through you that it stopped being able to run without you.

For an owner, the consequence shows up in the sale price, and it was set years before anyone made an offer.

What is key person risk?

Key person risk is the exposure a business carries when its operations, revenue or decisions depend on one individual to the point that the business cannot run properly without them.

That definition covers a specialist employee. It also covers the owner, and the owner version is both more common and more expensive, because a buyer can replace an employee. They cannot replace you, since you are the person selling and leaving.

What is another name for key person risk?

You will see the same idea called key man risk, key person dependency, or owner dependency. The insurance industry generally says key man risk. Advisers and buyers tend to say key person dependency. We use owner dependency, because it names who the person usually is.

The terms are interchangeable. What differs is who they assume the person is, and that assumption changes the advice you get.

How do you identify key person risk?

Buyers do this quickly, and they do it by asking questions rather than reading your financials. Four questions tell them most of it.

Who else can approve money? If payments, pricing and spending decisions all route through one person, that person is the business. Buyers ask this early because the answer is binary.

What happens to new work if that person stops? In a lot of owner-led businesses, sales come from the owner's relationships. Revenue continues for a while on existing contracts, then stops.

Who do the customers think they are buying from? Ask a long-standing client who they deal with. If they name a person rather than the business, that relationship may not transfer.

Where do the answers live? When a buyer asks how something works and the answer is "ask the owner," they have found what they were looking for.

You can run all four on yourself this afternoon, and the answers tend to be uncomfortable enough to be worth having early.

Here's what it sounds like when we sit down with an owner for the first time. We ask what the plan is. Nine times out of ten the answer comes back almost word for word:

Those owners aren't confused about their situation. They can describe it precisely. What they haven't done is work out that the description has a price attached to it.

What are the risks of key person dependency?

The operational risks are the ones people list: work stalls if you are ill, the team waits on you, growth caps at your personal capacity, and you cannot take a proper holiday.

Those are real, and they are the ones owners feel. They are also not the expensive part.

The expensive part shows up when you sell. Buyers respond to dependency in four ways, and they usually apply more than one at once.

They pay less. A business that needs its owner carries more risk, and risk comes off the multiple.

They restructure the deal. More of the price moves into an earn-out, so you only get paid the rest if the business performs after you leave. You are now carrying the risk you created.

They extend the handover. Instead of a clean exit you are tied in for a year or two, which matters if you were selling to get your life back.

Some buyers decline altogether, because they will not take on a business where the seller is the operating system.

The multiple you are offered is covered in our upcoming guide to valuing a business (Blog 7, publishing soon), and the way dependency lengthens due diligence and lowers the final figure is set out in our guide to how a sale works.

How do you reduce key person risk?

Search this and you will get the same four answers everywhere: key person insurance, cross-training, succession planning and documentation.

None of them are wrong. They are all written for a business where the key person works for someone, and they all assume something an owner-led business does not have yet.

Key person insurance pays the business a sum if a key individual dies or becomes disabled. It is a genuine product and it is worth having for the right situations. It does nothing about the problem here. A buyer discounting your business because it depends on you is not going to be reassured by a policy, and the policy does not pay out when you retire and sell.

Cross-training moves tasks. It does not move judgement, relationships or the authority to decide, which are the parts of an owner's role that hold the value.

Succession planning assumes a structure where someone identifies and grooms a successor. In an owner-led business, you are that structure. Nobody is planning your succession but you.

Documentation gets closest, and it is still not the fix. Writing down how the work is done transfers know-how. It does not transfer the authority to decide or the relationships the work depends on, which is why owners can produce a full set of procedures and remain exactly as necessary as they were. our upcoming guide to standard operating procedures (Blog 4, publishing soon) covers what good ones look like and where they stop.

The thing all four assume is a business with more than one decision-maker in it. That is the work, and it sits underneath the standard advice rather than alongside it.

Move real decisions to other people, and accept that some will be made worse than you would have made them. Put the customer relationships in the business rather than in your phone. Give someone else authority to approve money, with limits you can live with.

The trap of moving it instead of removing it

There is a version of this work that looks like success and is not.

An owner documents the processes properly. They promote a senior person who has been there a decade, hand over the day to day, and step back from operations. From the outside it worked. The owner is no longer in everything.

Then that senior person takes four weeks off, and the work starts landing back on the owner's desk. The documentation held. What went with the person was everything that was never written down, because it went into their head rather than into the business. The pricing judgement on unusual jobs. The knowledge of which client will accept what. The reason a decision was made three years ago that everyone still follows.

The business now has one irreplaceable person. It is a different person, which feels like progress, and to a buyer it is the same problem. They are still buying a business where a single individual holds knowledge nobody else can reach.

This is the honest version of what makes the work hard. Documentation moves tasks. Promotion moves the desk the tasks land on. Neither of those distributes the judgement, and judgement is what a buyer is pricing.

So the test to apply is whether any single person leaving would stop the business working. Being out of it yourself is only half the answer.

Do that and the standard four start working. Succession planning has someone to succeed to. Cross-training moves authority as well as tasks. Documentation becomes evidence instead of a filing exercise. Insurance goes back to covering a key employee, which is what it was built for.

Then leave it running that way long enough to be provable, because proof is the part a buyer pays for. That takes months rather than weeks.

What does it cost to leave it?

Every year you stay the key person, the business grows worth more on paper and becomes harder to hand over in practice.

Owners often assume those move together. They do not. You can double revenue and still reduce what the business will sell for, if the extra revenue runs through you.

The cost is not a line in your accounts, which is why it goes unnoticed until the sale. By then it is priced in, and the time needed to fix it has run out. our guide to how a sale works covers where in the process that becomes visible.

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