Key Insight
Owner dependency is when the seller is the key person. Key person risk is when someone who isn't the seller is the key person. Both are dangerous; the second is harder to see in due diligence.
Key Person vs. Owner Dependency
Owner dependency: The current owner is the linchpin. This is visible in due diligence and typically disclosed or discoverable. The solution is a longer transition period, earnout, or price adjustment.
Key person risk: An employee — the operations manager, the lead technician, the head of sales, the head of IT — is the operational linchpin. If they leave post-close (perhaps because the acquisition destabilizes them or the new owner isn't a fit), the business loses critical capacity.
How to Identify Key Person Risk
- Org chart analysis: Who has unique knowledge, relationships, or certifications that no one else holds?
- Employee interviews: Who do other employees call when there's a problem? Who are customers actually dealing with?
- License and certification review: Are any required licenses held by an individual rather than the entity?
- Customer relationship mapping: When a customer calls, who do they ask for?
- Succession depth: If the #2 person left, who becomes #2?
Pricing and Structuring Around Key Person Risk
If a key employee is identified during diligence, options include:
- Retention agreements: Offer employment contracts with retention bonuses tied to staying through the transition
- Earnout structure: Tie part of the seller's earnout to key employee retention
- Price reduction: If the key person is unlikely to stay, price the risk in
- Walk away: If the business cannot function without someone who won't be retained, the business isn't acquirable at a premium price
Key Person Insurance
Some SBA lenders require key person life and disability insurance as a loan condition — particularly when a specific individual (whether the buyer or an employee) is critical to the business's cash flow. The business is the beneficiary.
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