It makes sense that a closely held business would be worth less when the key person is no longer going to be part of the business. In fact, this is often the case when the valuation is being performed for an estate when the decedent was the key person in the business. But, “there’s really nothing in the literature that really supports this,” a NACVA member commented.
And, a “key person discount” would have to cover many variables. There can be a business where a 10% owner controls all five of the major accounts. Or, there can be cases where two 50% owners would have different discounts if they were no longer in the business.
Most attendees at the NACVA/IBA session on adjustments to company financials said they felt more comfortable trying to account for this factor by adjusting either the income stream, or the company specific risk component of the discount rate.
“Judges do not generally like company specific risk,” says Gary Trugman (Trugman Valuation Associates). “That’s where I’d like to put the impact of losing a key person, but sometimes this decision can increase the likelihood that your valuation is challenged at some point.
Another concern that many appraisers see regularly: the key person hires you, but they’re not as “key” as they think they are. Trugman said “we’ve all seen businesses where the key person has stalled growth. The kids or next generation takes over and suddenly it’s like you’re on a rocket ship. In those cases, should we take a key person premium?” You need to meet all the managers and potential managers to make a correct assessment, Trugman says:
"Maybe Dad really is the mover and shaker, and the kids aren’t ready yet. But, often times, this story is the opposite. Your judgments in reasonable compensation and key person discounts and income stream and debt capacity (if the key person is the only person with access to credit) will all be influenced by how much of the business’ capability resides with the key person.”
Key person situations play a role in competitive analysis too; death isn’t the only form of separation that can influence value conclusions. Often the key person leaves–only to open their own doors across the street as a competitor.
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