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What is 'key person reliance' and what does it mean for your business?

We often hear from proud small business owners that “their customers will be with them until the day they die”. A business is often a projection of the owner’s identity, and in many aspects of running a business it’s a positive and necessary thing. However, a business that relies heavily on its owner is not as valuable as the business that can operate more autonomously.

Many business owners don’t understand how reducing or minimising the risk of key person reliance can significantly improve the value of their business.

Compare the following valuation scenario of the same business when the key person reliance is reduced or minimised:

 

 

Business Key Person Reliant

Same business not Key Person Reliant

Business Profit

$200,000

$200,000

Business Capitalisation rate

3.05

3.5

Value Improvement

 

$90,000

% of Value Improvement

 

14.75%

 

Buyers will pay a higher price for a business that can be easily integrated into their current business or smoothly transitioned to a new principal. They will want some comfort that the business’ key customers and staff will stay with the business once the current owner departs.

What can you do to reduce or minimise the risks of key person reliance?

There are many different business and risk management strategies business owners can implement to reduce or minimise key person reliance. The table below provides some suggested examples:

 

Strategies

Action

Business

1.    Business Systems: introduce systems into your business. For example, a good quality stock management system will reduce reliance on the owner’s product and services knowledge.  

2.    Client Relationship Management: establish customer relationship management protocols so staff can manage key customer relationships.  

3.    Management Succession: invest in the professional development of your key staff so they can eventually share in part ownership (succession planning) of the business

Risk management

The very nature of some businesses means it is difficult if not impossible to reduce or remove key person reliance. A specialist surgeon is an example of an occupation that will always be key person reliant. In this case where key person reliance cannot be removed or reduced the purchase of business insurance is considered an effective risk management strategy

Start with assessing the impact of key person reliance in your business by completing a business valuation. And remember- reducing the key person reliance does not mean removing your business’ identity, it’s about implementing processes that allow your business to retain its identity without your direct involvement.

Nexis Accountants and Business Advisors have a well-established system that allows us to assess the risk of key person reliance in your business and suggest a strategy to mitigate it and increase the value of your business.