Ask a business owner about their key person risk and they’ll talk about the star salesperson who holds half the client relationships, or the technical expert nobody else can replicate, or the long-serving manager who knows where everything is. They’ve thought about it and they know who the business would struggle without.
But very few of them have applied the same question to themselves.
What is “Key Person Risk”?
This is used to describe an individual that a business depends too heavily on. This can be as simple as a person who knows what to do when a piece of equipment stops working, or knows who to speak to when something needs fixing. It can also be more complicated, such as the person who holds the key client relationships and, as the business owner, that person is often you.
When it comes to selling your business, it’s seen as a red flag, because the business performance is tied to one persons involvement.
It changes how your business is valued and how a deal will be structured. It can also result in the buyer deciding to walk away.
Most owners are aware of key person risk in principle, they just tend to apply it to everyone else and forget about themselves.
The blind spot
Think about the people around you in your business. You can probably name the people you would struggle without, and you’ve probably thought about what you’d do if they were to leave. You may even have thought about who could step into their role.
But have you thought about you, the business owner?
In most businesses, you are the single largest key person risk. The smaller the business, the more the owner does. The gap between the owners involvement and the next person is often enormous.
It’s easy to see why you don’t consider yourself a risk. It’s hard to imagine yourself as the problem. It’s easy to convince yourself that your involvement is different, you’re not a risk, and you’re the owner so you have to close to things. Sometimes that’s true, but often, it not the case at all.
Are you a Key Person Risk to your business?
Take the Business Dependency Test.
It takes less than 3 minutes and will give you a clear answer.
What does founder key person risk looks like?
It shows up in different ways and they are obvious, once you know what to look for.
Do you have clients who only deal with you personally, and you’ve never introduced to anyone else? Not because there’s no one else who can have that relationship, but because it’s never been an issue.
Are there decisions that what until you’re available to make them? Do proposals, quotes, contracts, complaints, or anything else that stops until you get involved?
Is there knowledge in your head, such as pricing or why a client is handled differently? Are there judgment calls that nobody else can make, because they don’t understand the history?
How much of this applies to you and your business? The more that does, the more that your business isn’t really a business in the way a buyer or investor would see it. It’s seen a set of relationships and processes, that belong to you.
How does a buyer use this information
When a buyer looks at a business, the owner is a key person. When the owner is heavily involved in the day-to-day running, then they’re not buying a business. They’re buying a job, that has client commitments, staff expectations, as well as a range of other demands. What makes it worse is that the one person who actually knew how to do everything, is about to leave.
A buyer will factor this in and offer a lower price, want a longer earn out period to keep you tied in, or add other conditions to the deal. In some cases, this results in no deal at all.
This is covered in more detail in What Buyers Look For In A Business. Owner dependency sits at the top of a list of buyer concerns, and it’s a major thing that they’ll be looking for during their due diligence. If it’s there, they’ll find it if.
Owners assume that an earn-out is a normal part of a deal structure. This is true, but if it’s driven by key person risk, then the buyer means: we’re not confident the business will work without you, so we want you to stay and prove it will.
This problem can be avoided
Key person risk, unlike some of the other items that impact a business’s value, can be fixed. It takes time and effort, but it’s not a problem with the business itself. It’s a problem caused by the way the business has been run, and it can be changed.
The work to change it involves three things:
You need to transfer knowledge out of your head, and put it into documented processes and systems.
Clients need to be introduced to other members of your team, so those relationships can develop over time. This does not mean handing all of the clients to someone else, and it doesn’t mean handing them over to someone else overnight. It does mean gradually reducing the client’s loyalty to you as a person.
It also needs you to push decisions down to those people who are capable of making them. This needs you to give them authority to make those decisions, and you have to be able to live with decisions they make, whilst accepting that they will be made differently to how you’d make them.
How To Document Business Processes covers setting up systems.
Get Your Team To Take Ownership looks at the decision-making and creating the culture you need.
None of this needs to happen quickly, or feel like a major change. It’s a gradual process, but it needs to start somewhere. If your business functions well without you, it’s worth a lot more, takes less out of your day, and is a lot easier to sell when the time comes.
The bottleneck test in The Business Bottleneck is worth looking at with this in mind. The questions there are a diagnostic for key person risk, applied to the owner.
Are you the biggest key person risk in your own business?