Key Man Risk is the risk that accompanies there being one highly integral member of a business. The absence of this crucial person could cause a company to crash, as this person is critical in business functionality over any number of factors. How does one assess the Key Man Risk when acquiring a small business?
To assess Key Man Risk, one must identify the key man and determine dependency, retention, succession, diversification, and revision. Determining Key Man Risk is essential in small business acquisition as small businesses have fewer staff members and a higher likelihood of risk.
We will assess the Key Man Risks when considering a small business acquisition. These risks are a considerable problem in small businesses, and we will look at how to recognize the problem areas and identify the signs of solid business practices that will allow for the acquisition and further growth and profit.
What Is The Key Man Risk In A Small Business Acquisition?
Key Man Risk is the risk that one or a few key individuals in a business are responsible for most of the knowledge, skills, and relationships required to keep the business running. Should this person or group leave a business, the company is at risk of failing due to the sudden loss of this person or persons.
When considering a small business acquisition, let us examine the various factors to determine risks.
In a small business, this is often the owner.
Examples of Key Man Risk that I have seen in small businesses for sale.
- The owner has regularly played golf for years with the largest clients.
- The owner has personal knowledge of a method or process that has not been documented or shared with employees.
- A manager is roommates with a few employees.
- Special pricing is provided by a supplier because the owner utilizes that supplier for other businesses.
Identify The Key Man
The first step is identifying if there are any vital individuals in the business. In small businesses, the owner will often be the key man in the company. It’s, therefore, integral to a successful transaction that this person alone is not responsible for the business’s success. If so, this is a huge issue.
Key person identification can go beyond the clear identification of management and leaders. While management will often have critical skills and knowledge, key persons who work with the business, such as service providers, can also be considered. Staff who maintain most business relationships can also be critical in function.
Identifying this person or persons is often as simple as spending time in the office observing general workings. Still, one can also use company organograms, surveys, and feedback to determine the key individuals.
Determine The Extent Of Dependency
Once you have identified the key man or persons, it is vital to determine the extent of the company’s dependency on the individual. When making your assessments, looking at employee turnover and investigating whether the company retains its customer base and how is essential.
If the company’s success is limited to the key man, then this could make acquisition easier if the key man remains with the company. This is due to skills, knowledge loss, and relationship building.
An often forgotten factor is the power of well-maintained relationships and networks, which can take many years to develop; if the key man is integral in keeping those avenues open, then the business will suffer badly in their absence.
A key staff member can have a massive impact on a business, both in its success and possible failure. Knowing who the key man is and the extent of their influence is vital in small business acquisition.
Consider Key Man Retention
Suppose the business relies on the key man for optimal functionality. In that case, you can decide to enter negotiations with the key individual to create a package that will entail their staff staying after the small business acquisition.
This could include bonuses, shares, and opportunities to advance their career. Regardless of which carrot you use to retain the key man, you must keep clear communication with them so they are assured of the future to mitigate Key Man Risk.
A fixed-term contract that allows for an option for renewal is the simplest way to provide yourself with peace of mind, as this will enable you to know that the business will continue successfully and that you have a set period in which to ensure skill and knowledge transfer for the continuation of the business interests in the long term.
Identify Key Man Successors
A further critical element is determining whether the company has possible successors for the key personnel and whether any structures have been put in place for skill and knowledge transfer.
Should the key man leave, you must ensure the company can continue without them after a small business acquisition. Identifying which staff can become backups and successors is, therefore, as important as determining who the key man is when assessing Key Man Risks.
These successors will need to be able to pick up on and learn the skills and knowledge of the key person and maintain relationships. Pick a few people for the purpose, as this will allow you to better ensure the stability and longevity of the company by delegating only some of the power to a single person.
Succession identification is not only crucial for the initial acquisition. Succession planning should be an ongoing project where successors and backups are continuously developed, monitored, and evaluated.
Broaden Key Man Values
This looks at diversifying the key man role beyond a single individual. To diversify your key man role, you must determine the strengths of all staff members and allow qualified staff more responsibility. When assessing an acquisition of a small business, it’s a good idea to see if the company has already started delegation of tasks as well as cross-training.
Suppose the company shows signs that key man values have been diversified. In that case, it’s a good sign that they have identified the possible danger of being reliant on a key man and have proactively put in place procedures for future growth and reducing the potential risks of a key man scenario.
Keep Revising Key Person Risk
It’s advisable to continually review Key Man Risks, even during the small business acquisition. Things can change quickly in business, so maintaining clear communications with staff and encouraging growth and skills transfer is a good idea.
Part of the Key Man Risk review is anticipating industry or business changes. Will any staff member need to be off on maternity leave, or does any staff member have an illness or injury that may require weeks off work? Changes may also be within the business sector itself.
Due to these, continual revision and assessment of risks will allow you to plan for the mitigation of problems in the future.
Conclusion
When acquiring a small business, Key Man Risk is a significant factor. With small businesses relying on small staff complements, it’s often common for individuals to be business superstars. It’s essential to assess if this is the case in an acquisition and determine how best to mitigate this risk.