Definition of Key
Employee
Most often, a key employee (key man) possesses
characteristics that distinguish him from other employees:
-
He might have a specialized skill that is
critical to the success of the business. A replacement might possess
the same skills but he may have to be recruited at higher compensation
levels
-
He has a strong customer base and is
responsible for attracting a significant amount of business
-
He is a source of capital if his absence
will damage the credit rating of the business.
In reality, identifying a key employee
might be mere difficult than it seems. The term "key employee" is not
necessarily limited to employees of the company. It may include
business owner employees as well. In the initial operation of any
business, the owners usually play an important role in building the
business and can be classified as key employees.
How do we lose a key employee? A key
employee can be lost as a result of death, disability or resignation.
As such, the proper wealth preservation planning to protect business
interests involves managing the risks and losses incurred if any of the
above happens.
How a Key Employee Is
Valued?
Putting a monetary value on a key employee's contribution to the
business is even more speculative than valuing the business itself. The
actual valuation method used is very much dependent on the
characteristic of the employee that makes him "key" to the business;
for examples, "a sales manager who has substantial impact upon sales or
a financial officer who has access to credit".
Four most commonly used methods are:
-
Contribution to profits. This method
estimates the employee's impact on profits each year, then capitalizes
that contribution over the number of years it takes to find and train a
replacement
-
Business-life value. In this approach,
the estimated decrease in business earnings is multiplied by the years
of work left in the key employee's career. The decrease in business
earnings can be traced to the employee's effort, skills, knowledge,
talents, contacts, sales results and other attributes. The outcome is
then discounted (reduced) using a reasonable interest rate
-
Multiple of salary. Assuming salary to be
a fair measure of a key employee's value to the business, multiply it
with a factor of between three and 10, depending on how valuable the
employee is perceived to be
-
Discount of the business. This approach
estimates the percentage reduction in the business' going concern value
that would result from the loss of the key employee. That percentage is
then multiplied by the business' going concern value.
The task of evaluating a key employee's
worth to a business will always require some form of discretion and
therefore can never be totally precise and accurate.
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