From technical know-how to charisma and innovation, the skills and personal attributes of a company’s leaders are often critical to its success. But those same traits can become a source of risk if the business relies too heavily on its founder or another top manager.
If a so-called “key person” becomes incapacitated, retires or unexpectedly leaves, it can disrupt day-to-day operations, unsettle customers and lenders, and strain working capital. As you plan for the new year, take a moment to consider whether your business faces key person risks — and, if so, how to think like an auditor to proactively manage them.
No organization is immune
Financial statement auditors are required to perform a risk assessment as part of audit planning and execution. One potential source of risk is overreliance on one or two individuals for leadership, revenue generation or institutional knowledge.
Key person risks are usually associated with small businesses, but they can also impact large multinationals. Consider the stock price fluctuations that Apple experienced following the death of innovator Steve Jobs. Fortunately for Apple and its investors, the company had a deep management bench, a strong pipeline of technology and sufficient working capital to bridge the transition period. However, many small businesses lack those buffers and may take years to recover from the sudden loss of a key leader.
Factors to consider
Does your business rely heavily on one or two individuals, or is your management team sufficiently decentralized? Key people typically:
- Handle broad duties,
- Possess specialized training or industry knowledge,
- Have extensive experience that isn’t formally documented, or
- Make significant contributions to annual sales or customer relationships.
Auditors also consider whether an individual has signed personal guarantees for business debts, as well as the depth and qualifications of other management team members. Generally, companies that sell products tend to be better positioned to withstand the loss of a key person than service-based businesses, where relationships and expertise are harder to transfer. That said, a product-based company that relies heavily on technology may be at risk if a key person possesses specialized technical knowledge.
Customer and supplier relationships are also important factors. When those relationships are concentrated in a single individual, the departure of that person can create instability and lost business. Companies are better able to retain relationships when they’re shared across multiple team members.
Mitigating your exposure
An audit risk assessment can help identify where key person risk may exist and prompt discussions about business continuity and resilience. While auditors don’t design succession plans or internal controls, the process often highlights vulnerabilities that management may want to address through training programs and succession planning options. Contact us to help assess key person risks and brainstorm practical solutions to strengthen your company’s long-term stability.
