Key Person Discounts: When They Apply, and How Much They Actually Cost
A key person discount reduces a business's value because the business depends heavily on one person, and a buyer would pay less for that risk. There is no standard percentage, and anyone who quotes one without evidence is guessing.
When the risk is real
Dependence on an individual shows up in specific facts:
customer or referral relationships held by the owner personally
technical skill, licenses, or certifications that only the owner holds
a franchise, dealer, or supplier agreement that names a particular principal
a thin management team with no one able to run the business in the owner's absence
lenders or bonding companies that rely on the owner's personal guarantee and reputation
key person life or disability insurance, which shows the business itself recognized the dependence
If the business has a deep management team, recurring revenue, and written supplier relationships, the discount is hard to support.
The insight: it is one risk with four possible places to put it
Owner dependence can be handled in several ways, and a report should pick the one that fits the facts:
The cash flows. Normalizing owner compensation to the cost of a replacement manager already prices the owner's labor (see article 2).
The discount rate. A company-specific risk premium raises the rate for a business with concentrated dependence.
A separate discount. A percentage reduction applied to the value after the other steps.
A personal goodwill carve-out. Some of the value is treated as the owner's own and not the business's (see article 1).
These overlap. Replacing the owner's pay with a market salary, adding a company-specific risk premium, applying a key person discount, and excluding personal goodwill can each be defended. Doing all four to the same dollars removes the same risk four times.
A simple test
Ask the expert to state the owner-dependence risk in one sentence, then show where in the report it is handled. There should be one answer, and it should be consistent with the compensation adjustment and the goodwill treatment.
Evidence that supports or weakens the discount
What happened to revenue when the owner was absent for an extended period, for illness or travel
Customer concentration and who holds the relationships
Management depth and the tenure of the people below the owner
Whether a succession plan exists
Whether the owner is expected to stay, which bears on whether the discount reflects a real risk to the person who will own the business after the case
Questions to ask your expert
What specific facts show dependence on the owner?
Where in the report is that risk handled: cash flows, discount rate, a separate discount, or goodwill?
How does the treatment fit with the compensation adjustment?
What is the evidence for the size of the discount?
How much would the conclusion change without it?
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