What is key person risk in an agency?
Agencies sell relationships, and relationships sit with people. Key person risk is the chance that income falls when one person leaves, retires or simply stops being involved after a sale. It looks different in each type of agency:
- ·Real estate: a principal who lists most of the sales and personally holds the larger landlord relationships on the rent roll.
- ·Insurance broking: commercial accounts that deal with one account executive and could follow that person to another brokerage.
- ·Mortgage broking: referral partners, such as accountants and real estate offices, who send clients to the principal by name.
- ·Financial advice: clients who see one adviser as their planner rather than the practice.
- ·Marketing, digital and creative: a founder who wins the pitches and remains the client's main contact.
- ·Recruitment: a top biller whose client relationships produce a large share of placement fees.
- ·Travel: corporate accounts serviced by one consultant.
How does a valuer measure key person risk?
Assertion is not evidence. A valuer tests dependence from the records in four ways.
First, revenue attribution: how much revenue comes from clients, landlords or referrers whose main contact is the key person, taken from your systems rather than memory. Second, relationship depth: whether those clients already know a second person who services them, and whether they stayed through past staff changes. Third, operational dependence: what happens to pricing, quality and approvals when the person is away for a month. Fourth, contracts: employment terms, notice and restraint clauses for key staff, and whether any licence or authorisation the business needs is held by one individual.
The answers decide whether the risk is minor and absorbed in ordinary normalisation, or large enough to change the value.
How does key person risk change the value?
There is no published table of key person discounts, and a figure quoted without reference to the agency is a guess. A valuer reflects the risk in one of two broad ways and says which. The first is in maintainable earnings: allowing for revenue likely to be lost, or for the cost of employing someone to do the key person's work at a market salary. The second is in the capitalisation rate or multiple, adjusted for the extra risk. The ATO's guide to market valuation lists lack of support for size, risk and other adjustments to a capitalisation multiple among the common issues it sees, so the reasons belong in the report.
Where income follows the person so closely that it would not transfer to a buyer at all, the question changes from how large a discount to how much of the goodwill belongs to the business rather than the individual.
Hypothetical illustration: a principal-led mortgage broking business
Invented figures, not market data. A mortgage broking business earns $900,000 a year. Part is trail income on loans already settled; part is upfront income on new loans. The principal writes most new loans and holds the referral relationships.
A valuer might treat the two income streams differently. Trail on the existing book is paid on loans already written, subject to the aggregator and lender agreements, refinancing and clawback, so it depends less on the principal staying. New lending depends heavily on who brings in the clients. If the principal will leave at settlement, the valuer may assume new lending falls until the referral relationships are rebuilt, or deduct the cost of hiring an experienced broker at market pay. If the principal will stay for an agreed handover, the report states that assumption and what happens if it is not met.
How can you reduce key person risk before a sale?
Most of the fix is operational, and it takes time to show in the records. Buyers usually manage the risk that remains through the deal itself, with a handover or consulting period, a restraint on the seller, or some of the price deferred in an earn-out.
- ·Introduce a second point of contact for every large client, landlord and referral partner, and let them deal with that person directly.
- ·Hand new business and renewals to the team while you are still there to support them.
- ·Write down how the agency prices, delivers and approves work, so the knowledge does not live in one head.
- ·Put key staff on clear employment terms, with legal advice on notice and restraint clauses.
- ·Plan the handover period you would offer a buyer, and keep a succession plan; business.gov.au suggests sellers refer to one when they decide to sell.
- ·Treat key person insurance as cover for the financial shock of losing someone, not a replacement for the relationships.
What do we need from you?
To assess key person risk from evidence, we usually ask for:
- ·Revenue by client, landlord or referral source for the last two to three years
- ·A staff list showing who services each of the larger relationships
- ·Employment agreements for key staff, and any shareholders or partnership agreement
- ·How each working owner is paid and the role each performs
- ·Your proposed handover terms, if a sale is in view
What does an agency valuation cost?
Each valuation is a fixed fee, set in writing before work starts, and it does not move with the value or with any sale. The band is set by the annual revenue, excluding GST, of what is valued: a rent roll's annual management income, an insurance or mortgage book's annual recurring income, or the agency's total annual turnover where the whole agency or shares or units in it are valued. Delivery time starts once payment and all required information have been received.
- ·Small Business Valuation: $1,495 + GST where the revenue of what is valued is under $2 million, delivered in 2 business days
- ·Medium Business Valuation: $2,495 + GST from $2 million to $3 million, delivered in 3 business days
- ·Large Business Valuation: $3,495 + GST above $3 million up to $10 million, delivered in 3 business days
- ·Above $10 million: quoted in writing before work starts, with the delivery date agreed before commencement
- ·Expert report for a dispute or court: $4,495 + GST, with the delivery date agreed before commencement
- ·Add-ons: +$495 per retrospective (past) valuation date and +$795 per additional entity