How Key Person Risk Can Make or Break the Sale of Your Small Business

Succession planning is crucial for small and medium-sized enterprises (SMEs), but often overlooked. One of the biggest threats to business stability is key person risk, where the departure of a critical individual—whether an owner or not—could significantly impact the business. These key individuals may manage vital customer or supplier relationships, possess specialised knowledge, or play a central role in daily operations.

But how do you identify if someone is a “key person” in your business? Key persons are individuals whose absence could lead to significant financial, operational, or reputational damage. They might be technical experts, business development drivers, or maintainers of critical relationships with clients or suppliers. The loss of such people often has a direct effect on the company’s performance and valuation, making it vital for business owners to recognise and address this risk.

For SMEs, the absence of such a person can affect revenue, reputation, and operations, ultimately influencing the company’s valuation. William Buck’s Corporate Finance team highlights the importance of understanding and managing this risk when preparing for succession or business sales.

How to Identify Key Person Risk

Key person risk can be evaluated through methods like adjusting capitalisation multiples, applying earnings normalisations, or using discounts to the enterprise value. William Buck applies a 10-25% discount based on the company’s unique risks, helping businesses understand their vulnerabilities. To identify a key person, ask:

  • Who is responsible for maintaining major client or supplier relationships?
  • Who has specialised knowledge that is essential to the business’s operations?
  • Who drives key business functions, such as innovation, sales, or strategy?
  • Who is central to the business’s day-to-day management?

These individuals are usually not just owners, but anyone whose departure would disrupt the flow of business or affect its financial health.

What SMEs Can Do to Address Key Person Risk

  1. Customer and Supplier Relationships: Ensure these relationships are transferred beyond a single individual, possibly with non-compete clauses.
  2. Technical Expertise: Document key processes and train staff to prevent the loss of niche knowledge.
  3. Operational Involvement: Spread operational responsibilities across the team to avoid dependency on one person.
  4. Reputation and Network: Build a strong brand and network to protect the business’s standing if a key person leaves.
  5. Employee Loyalty: Cultivate a culture of shared values and mission to maintain morale and reduce turnover.
  6. Strategic Vision: Develop a diverse management team to carry the company’s strategy forward, ensuring stability.

Preparing for Sale or Succession

For SME owners considering a sale, addressing key person risk is crucial to improving business valuation. A business reliant on a few individuals is typically valued lower, as it’s seen as more vulnerable to disruptions. Proactively mitigating key person risks not only strengthens the business but also positions it for a more successful transition.

In short, understanding and managing key person risk is key to safeguarding business value, particularly when preparing for succession or a sale. SMEs that take these steps can improve long-term stability and ensure a smoother handover when the time comes.

The post How Key Person Risk Can Make or Break the Sale of Your Small Business appeared first on Small Business Connections.

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