Key-Person Risk

The risk that a business's earnings depend heavily on one specific individual's relationships, judgement or reputation, and will not survive their departure intact.

Example

A landscaping business where every major customer relationship runs through the founder personally carries high key-person risk once that founder sells and leaves.

Important

It is the reason small-business multiples sit well below multiples paid for professionally managed companies with a full team already in place.

Related terms

• Owner-Operator — A business owner who personally works in the business full time, rather than employing a manager to run day-to-day operations on their behalf.
• Goodwill — The residual value of a business purchase left over once tangible assets are valued and liabilities assumed are subtracted, representing customer relationships, reputation and other intangible value expected to transfer to the new owner.
• SDE Multiple — The multiple applied to a small business's seller's discretionary earnings to arrive at a purchase price, negotiated based on factors including size, customer concentration, revenue durability and owner dependence.

Lessons that explain it

• References you chose tell you more than references you were given — Checking the people behind an investment means verifying claims, speaking to sources they did not nominate, and asking questions specific enough that a vague answer is itself informative. (11 min)
• Ask how the manager gets rich, and whether it requires you to — Fund economics shape manager behaviour. Alignment is strongest when managers commit meaningful personal capital, depend on carry rather than fees, and keep fund sizes suited to their strategy. (10 min)
• The clauses that decide what happens when something goes wrong — Beyond fees and carry, a fund's agreement governs who must stay, how capital can be reused, what happens if LPs lose confidence, and what you are entitled to know. (12 min)
• Good board members ask the question nobody else will, then let management run the company — An effective board member prepares, focuses on the few decisions boards actually own, asks hard questions early, and resists the urge to manage the company from the boardroom. (10 min)
• The hardest board decision, and the one most often made too late — Replacing a founder chief executive is rare, disruptive and sometimes necessary. Boards tend to delay it, and the cost of delay is usually larger than the cost of the decision. (12 min)
• Appraising one fund: where returns came from, and how often deals lost money — A buyout track record is judged by its dispersion, its loss rate and the source of its gains, not by the average multiple. (13 min)

All 578 terms in the Investing glossary