The “Key Man” Dependency Could Be Lowering Your Valuation
Business owners and founders pour time, energy, and vision into their company often making them indispensable to the company’s success. However with M&A, indispensability is a liability.
If one person disproportionately accounts for a business’s success, it can raise concern about what the company’s value would be without him or her. If every major decision, key client relationship, and operational know-how resides solely in the owner, the potential buyer may not consider the company as a transferable asset. Lowering dependency score is the single most effective way to de-risk the deal for a buyer and, consequently, drive a premium valuation.
High Dependency Means Lower Multiples
During the due diligence process, sophisticated buyers will look for issues in a company’s operational structure to see if it collapses without the owner. This is often referred to as the “Key Man” discount. If a buyer determines the business is too dependent on the owner, they may respond by:
- Lowering the Multiple- Reducing the price to account for the risk when the owner exits.
- Aggressive Earn-Outs- Tying a large portion of the sale price to performance 2-3 years post-close.
- Walking Away- Many buyers won’t buy a business if the founder is the primary salesperson or sole decision-maker.
Minimize Dependency with the 90-Day Test
To avoid high dependency’s effect on value, owners should aim for the 90-Day Test: the ability for the business to operate, grow, and serve customers for three months without any input from the owner. Here are a few ways to lower dependency:
- Document all core processes and workflows in a centralized system
- Cross-train employees to ensure multiple people understand how to perform key tasks
- Introduce key client and vendor relationships to account managers or department heads
- Identify critical roles and develop internal talent to ensure leadership continuity if key employees leave
At ArkMalibu, we help sellers prepare their legacy for exit. Through our proprietary “Four Boxes” approach, we get to know your operations, culture, clients, and financial results & expectations to identify dependency traps before a buyer does. Our goal is to tell your company’s story in a way that highlights its institutional strength and self-sufficiency to best communicate value to investors or partners.