• Sat. Apr 20th, 2024

How to calculate the value of a key person

ByManali

Jul 28, 2023

In any business, a select number of people often play a crucial role in the company’s success. These ‘key people’ are essential to the business’s day-to-day operations and usually have knowledge and experience that would be extremely difficult to replace.

The loss of these key employees can have a profound impact on a business’ productivity or financial stability. Soit’s important to have some protection.

Key person insurance is one way to protect a business from losing an essential person due to death or critical illness.

Understanding the importance of a key person 

A key person is anyone whose expertise, skills, knowledge, or relationships are essential to an organisation. This person could be a CEO, a CFO, a skilled technician, or a top-performing salesperson. 

Identifying a key person can be challenging because it’s not always necessarily a senior person. Rather it’s someone with specific skills or relationships that would be hard to replace.

Factors to consider when calculating the value of a key person

Financial contribution

A key person’s value can often be measured by their financial contributions in relation to sales figures, marginsand profitability of the company – particularly when looking for key people in sales.

However, it is important also to consider the potential future financial contributions that the key person may be able to make.

For example, if they have a track record of developing new products or services that have been successful, there may be opportunities for them to do so again in the future.

Leadership and management skills

A key person may provide leadership and management skills that are essential to the business’s success. These skills can include strategic thinking, managing teams effectively, and strong communication and negotiation skills.

If losing these management or leadership skills could have a significantly negative impact on a business, then this person should be considered a key person.

Industry knowledge and expertise

Industry experts can bring a level of insight and knowledge that can be used to address complex challenges and make informed decisions, especially in niche industries or specific areas of a larger business.

Network and connections

A key person’s value can also be attributed to their network and connections. They may have relationships with important clients, suppliers, or regulatory bodies.

If the loss of an employee could put those relationships at risk, for example, if a client is with a business because of their relationship with a particular person, then they should be considered a key person.

Methods for calculating the value of a key person

There are several ways to calculate the value of a key person.

Replacement cost method

The replacement cost method involves calculating the cost of hiring and training a replacement for the key person, considering everything from advertising, recruiting and training expenses for filling the role.

It should also consider some ‘indirect’ costs too, such as the loss of productivity or profits in the period of replacing the key person.

This can be an effective method when looking at sales staff or those with niche skills that would be hard (and expensive) to replace.

Income approach

This approach estimates the future income that a businesswould lose if the key person were no longer at thecompany. This is a common method used when looking to replace sales or commercial staff based on their historical contribution to a business’ income.

Human capital value-added method

The human capital value-added method involves analysinga key person’s impact on the organisation’s performance, revenue, and customer relations.

This method takes into account both tangible and intangible contributions to the business, considering the key person’s leadership skills, ability to innovate, and impact on the company culture.

For example, if a key person has a significant influence on the company’s culture, the human capital value-added method can help estimate the value of that person to the organisation.

Understanding the value of key people

There’s no way of knowing what will happen in the future and businesses should ensure they’ve taken the necessary steps to protect themselves in the event of losing a key member of staff.

By having protection like key person insurance, businesses can at least reduce the financial impact of what will be an extremely difficult time and help to secure their short and long-term financial future.