Mitigate Key Person Risk

Key person risk is the most challenging and complex risk to mitigate. There are standard methods to manage and reduce business operational, credit, market, and legal risk. Key person risk also has the potential to sink a business. Standard business management practice entails managing risk, but key person dependency is often the company’s most overlooked risk. No set procedures and practices can recognize this risk or take measures to mitigate it.

When a business relies on key individuals and is not effectively managed, it faces a profit loss, a slump in productivity, and lower morale among other employees.

Related: Value Creation: Risk Mitigation. 

Understand Key Person Dependency Risk

Key person dependency can be summarized as a business’ dependency on one or two key persons who are primarily responsible for a department’s (or the entire company’s) performance. Their availability is essential to ensure continued operation, and their absence leads to chaos.

What Is a Key Person?

A key person is an employee with special skills and possesses critical knowledge in a particular business area or domain. They are experienced, have been in their jobs for a long time, and handle crises. They have also delivered superior performance in their department or business area.

In short, a key person is a go-to person upon whom everyone else relies due to their superior knowledge, expertise, and experience. Key persons need not be managers or leaders and sometimes work in non-technical domains.

How to Identify a Key Person?

  • They know how and where to unearth essential and valuable information.
  • They know their job, the company, and its industry inside out.
  • They possess the essential knowledge to identify the best methods and tools to handle any situation within their domain.
  • They know immediately whether a proposed solution will resolve problems or create a new set of issues.

Defining a Key Person’s Critical Knowledge

Critical knowledge is essential for both the person and the company. It is indispensable for the organization and gives the company an advantage over competitors in similar business domains.

Tacit knowledge is collective business know-how residing only in the key person’s head. It gives that person the advantage of responding instinctively and pragmatically. Since that knowledge is acquired through experience, it’s difficult for the company to find an adequate and capable replacement (employee) in times of need. If this person were to leave the company, that knowledge goes with them.

When a key person who has been with the company for several years leaves, the company also loses institutional knowledge. That’s a big problem should a general issue arise, and the only person who knows how to handle it no longer works for the company. Problems range from what questions to ask and whom to talk to regarding the problem to whether there is a process to handle the situation. Most businesses are vulnerable, as there is no set process to address the matter.

The Problem with Key Person Risk

Reliance on key individuals has several associated risks that may impact company profits, decrease productivity, and affect the confidence of remaining employees if not managed in a timely manner.

When such an indispensable employee leaves, the business may suffer a massive loss of valuable experience, skills, and expertise. One area most affected is IT. If the key person is an IT professional, they manage software licenses, anti-virus software, network, CRM tools, and much more. Replacing such a person can pose a serious problem, especially if no other qualified person is to assess the situation.

Evaluate the Business Risk

To understand if your business faces key person risk, answer the following questions:

  • How much time and money will it take to recruit a replacement?
  • Do you think it will be difficult to retain such a person and find a similarly skilled replacement if need be?
  • If this person goes on leave (planned or unplanned), will the business continue operation as before?
  • Will there be severe financial consequences if this person leaves suddenly?
  • Will your competitors take advantage of the loss of intellectual property?
  • Are there additional costs associated with attracting and retaining a replacement employee?

How to Mitigate Key Person Risk

Understand the issue and identify key people. An excellent place to start is to conduct a thorough workforce analysis to identify key people. Next, rate those employees according to the grade of risk they represent (high, medium, low). Finally, set a work continuity strategy to empower other employees who can carry out those responsibilities when and if needed.

Plan for succession by empowering someone else from the company. Begin by asking the key person to document their work, starting with a checklist of the tasks they perform. This inventory of work should include everything they have done and are doing. All such documents should be stored in a repository of shared knowledge so it’s accessible when needed.

Another way to mitigate the risk is to conduct extensive, on-the-job training of potential successors in key person’s domain. The “understudy” can gain essential knowledge through observation and imitation.

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Reduce Key Person Dependency

Key-person risk can be mitigated in the following ways:

  • Identify and train capable successors to stand in for the key person.
  • Take out insurance on the key person (if needed) to cover the risk of financial loss incurred due to their departure.
  • Set processes for mentoring, cross-training, work-shadowing, etc.
  • Create standard operating procedures and document all business processes.
  • Build an organizational framework to capture critical knowledge.
  • Consider outsourcing technical tasks such as IT services, telecom, etc.
Author Summary:
Dan Doran

Dan Doran

Is the Founder of Value Scout, Quantive and the 2019 Exit Planner of the Year. He is a recognized expert and speaks frequently about M&A, valuations, and developing more deliberate value creation strategies.

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