Managing Key Person Losses These people possess special talents, knowledge, reputations, or other characteristics that make them outstandingly valuable to that organization. For an organization, this can include employees, sometimes members of boards of directors, outside committees, and occasionally volunteers.

Human Resource Risks Human resource risk can be due to: Death Disability (temporary or permanent) Management error/incompetence Unexpected temporary leave Poor employee management practices

Key Person Losses Loss of a key person could result in: a loss of profits a loss of commercial standing a loss of confidence of staff, investors or the market a loss of key relationships, partners or clients a loss of unique intellectual property a loss of license conditions a loss of experience and track record wasting time and the expense of appointing a successor.

 Risk Assessment For each event, evaluate both the probability of occurrence and the consequence or impact of occurrence on a scale of 1 to 10, where 1 is low and 10 is high. You can think of the consequence of the event both in terms of severity and cost to the business. The first event in Table 1 is an owner of a business identifying as a possible risk a car accident that prevents or her from fulfilling her normal duties for six weeks. The owner rates the probability of a car accident at between 2 and 3. She rates the consequence of being unable to fulfill her duties for six weeks at 8.

Contingency Planning A contingency plan consists of six main sections: Executive Summary Risk Management Goals Risk Assessment Business Impact Analysis Risk Management Strategies Plan Maintenance

Business Impact Analysis An event such as the loss of key person can impact a business in three ways: operating impact, financial impact, and legal impact. Operating impact is loss of operating efficiency, such as decrease of sales or production volume due to the absence of key employees. Financial impact can include the loss of customers, increased costs, and cash flow problems. Legal impact can involve the inability to fulfill business contracts with suppliers, customers, or vendors.

Business Impact Analysis Outcomes The outcomes of the BIA are: The identification of resources needed to perform business activities The understanding/estimation of impact of downtime The inputs into the risk assessment are: The identification of required resources that may be impacted by a wide variety of threats (known and unknown) An understanding of business impact, which contributes to the prioritization of future control enhancements and risk mitigation strategies

Losses and Increased Expenses While this income loss may be temporary, there will be increased expenses, some of which will be of a permanent nature. These increased expenses relate to the following: The search firm costs relating to the hiring of a new employee. Training costs for the new hire Possible “signing” bonus Costs associated with paying an income to the disabled employee or deceased’s family.

Key Personnel Loss Examples These key people can be characterized in one, or more, of the following ways: Possesses specialized skills critical to the success of the business Has a significant customer or client base Is responsible for bringing large amounts of business to the business May be a source of capital Loss could impair the credit rating of the business Loss could result in loss of customer, employee and bank confidence

Four Traditional Approaches to Key Person Valuation Value Based on Salary Capitalization Method Reduction in Going Concern Maximum Insurable Value

Value Based on Salary Application of some multiple to the key person’s salary This approach could be used to pay for recruitment and training costs required to hire a replacement for a key person. In certain industries it may also be necessary to pay a signing bonus. These costs alone could represent two to three times the salary costs of the current key person. When we add loss due to reduced earnings, goodwill and employee moral, we could easily have a multiple of up to five times the current employee’s salary.

Capitalization Method Under this method, we capitalize, at some discount rate, corporate earnings that can be attributed to the key person. As the discount rate and corporate earnings will be subject to fluctuation as the general economy and the business earnings fluctuate, the value determined using this method should be reviewed annually.

Reduction in Going Concern Method This method calculates the loss in the going concern value of the business based on the loss of the key person. The loss in value, expressed in percentage terms, is applied to the going concern value. Example: The business has a going concern value of $1,000,000. It is estimated that the loss of a key person will reduce this value by 25%. The value of the key person is $1,000,000 x 25% = $250,000

Maximum Insurable Value Under this methodology, the insurance company determines the value. It assumes that the maximum amount of coverage an insurer will issue on a key person is that person’s worth to the company. The insurer base this on salary, key skill, and attribute information on which to base its decision.

Calculating the Value of a Person  Example of steps to calculating the value of a person: 1. Determine the planning period The planning period is the number of years that would be required to hire, train and develop a new employee to the point where s/he would be of the same value to the firm as the individual replaced. 2. Determine net revenue The net revenue for each year of the planning period will have to be estimated. We will need gross sales and the cost of goods sold to arrive at this number 3. Determine key person’s contribution The amount of the key person’s anticipated contribution to the gross sales revenue of the business, as a percentage, for each year of the planning period will have to be determined. 4. Calculate key employee compensation The total compensation of the key employee for the duration of the planning period will have to be estimated. This figure must also include the cost of all employer-paid employee benefits. 5. Calculate replacement costs All of the direct costs for each year of the planning period that relate to locating, hiring, compensating and training the replacement.

Internal Factors Influencing Employee Value What is the level of risk to the enterprise if the position is left vacant for an extended period? To what extent does the position: Drive revenue and impact bottom-line financial results? Involve developing strategy, designing new products, or creating growth opportunities for the organization? Require broad decision making authority? Involve relationships with external customers and key stakeholders? Influence the performance of or manage other critical positions?

External Factors Influencing Employee Value What is the current market value of the position? How has the value changed over time? How is the position valued by other companies? What is the degree of competition for qualified candidates for this position in the marketplace? To what extent does the position require the use of rare/unique capabilities and skill sets?

Minimizing Losses Through Insurance Key Person Life Insurance This type of coverage differs from regular life insurance in that it specifically covers individuals in a business who are crucial to company operations. It provides the business with an infusion of cash if an insured key employee dies, regardless of cause or place of death. These funds can help compensate for revenue lost as a result of the death, as well as pay off debts, buy out surviving shareholders’ interest from heirs and finance the costs of a new employee search or training programs. Key Person Disability Insurance This policy will provide funds to a business if an insured key employee becomes disabled and unable to work—partially or entirely. While standard disability insurance covers an employee’s lost salary and medical expenses, a key person disability policy provides funding to a business to make up for lost revenue, the cost of hiring a new employee and other related expenses.

Minimizing Key Personnel Losses Standard approaches include: treat and pay people well cross-training programs travel policies and procedures succession planning documentation and backups skills development programs job mirroring knowledge transfer programs key person insurance strong, rigorous compliance programs

Risk Reduction Strategies Wider risk issues such as loss of market confidence, reduction in credit rating, star quality, track record and relationship dependence. Lateral, non-standard approaches include: Identifying replacements from outside the organization Commissioning a recruiter to approach potential candidates and keep a short list Keep track of past employees Rotating employees regularly Finite contracts with planned termination Pre-written, ready for release public relations material announcing change of people.

Student Experiences What are your experiences identifying and controlling key person losses?