Key-person risk

Definition

Dependence of revenue or licenses on one person, usually the owner.

Why It Matters

This is the most common reason a small business is worth less than its earnings suggest, and diligence exists partly to map exactly what walks out with the seller. Work through it concretely: who the customers actually call, whose name is on the license, who sets pricing, who the crew will follow. Whatever comes back is either a cost to replace, which belongs in the price, or a reason to lengthen the transition and hold money back until the relationships have moved.

In numbers: If the owner personally holds the relationships behind $800,000 of a company's $2,000,000 revenue, the business's transferable value is closer to what survives the handshake than to the P&L; pricing the deal, a buyer models year one without 20% of that owner-held revenue and sees whether the loan still covers.