Explaining key person risk

Posted by AFRM on 4 November 2015

What does the term key person risk mean and what does it mean for businesses?

Kylie Neary explains key person risk.  

Kylie FINAL EDITED

BusinessDictionary.com defines key person as: Individual whose knowledgecreativity, inspiration, reputation, and/or skills are critical to the viability or growth of an organisation, and whose loss may cripple it.  I think that’s a fairly good summary.

When we then turn to key person risk for business, it’s the reliance on these people (whether it be one or more within the company) and what happens if they don’t turn up for work tomorrow, for 4 weeks, for 3 months, for 6 months.  Will there even still be a business to run after that amount of time?

It is our experience that, particularly small businesses, do not have a grasp on their key person exposure as it “wouldn’t happen to them”.  When you sit down with a business and draw up their operational diagram (sometimes for the first time) they have an enlightening moment when you workshop with them the true roles they cover.  Not only are they the CEO, they are the factory foreman, head sales person/customer relationship manager and HR manager, as an example.

Small businesses are particularly vulnerable to key person risk as they are typically undercapitalised, likely to be over drawn on their cash account, potentially have low financial literacy, are often technicians (not managers),  are resistant to pay for advice and have a low appreciation of the impact of risk.

An incident taking a key person out of the business will impact on revenue, increase cost of sales, reduce gross margin, increase expenses, lead to a loss of focus, potential attack from competitors, an inability to service loan facilities and reduce further access to capital. 

If businesses identify the critical functions with in the business and the key people who perform those functions they can complete an assessment of the financial impacts and relevant management strategies to mitigate effects and potential costs.  

If you're concerned about key person risk in your business please contact an AFRM adviser here.

The answer this quarter is provided by AFRM Human Capital Risk Analyst Kylie Neary. Kylie is based in our Newcastle office and her role at AFRM focuses on analysing succession and keyperson risks associated with SMEs.

 

Please note, this information has been prepared by Australian Financial Risk Management Pty Ltd (AFRM) ABN 21 001 696 868. AFRM hold an Australian Financial Services License (AFSL) 237186. The information is for general purposes only and has been prepared without taking account of your objectives, financial situation or needs. AFRM recommends that you seek professional advice before acting on any information contained herein.

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