How Much Is Your Key Person Worth to Your Florida Business?

To measure what a key person is worth to your business, estimate the profit the business would lose if that person could no longer work. Then add the one-time costs of replacing them. Keep that number separate from the value of the whole company. This guide walks through the steps and the rules that change the math.

Why a key person’s value is not the same as the business’s value

A key person’s value is the financial loss your business would suffer if that person died or became disabled. That figure is different from what the whole company is worth. It is also different from what the person is paid.

Key person life or disability insurance can help a business cover financial losses caused by a key employee’s death or disability. Insurance Information Institute That purpose shapes the math. The question is what the business loses, not what the person earns.

Two mistakes to avoid. The first is using total business value as the key person figure. The second is using only the person’s salary. A salary is a cost. It says little about the revenue, relationships and decisions that person supports.

Start with the three valuation approaches

A business owner setting key person coverage may first want to know what the business is worth, and there are three common approaches to that question: the asset approach, the income approach and the market approach. Each one answers a different question.

The asset approach adds up what the business owns and subtracts what it owes. That gives a net asset value. The income approach estimates the profit the business can expect to earn. The market approach looks at prices paid for similar businesses.

Federal estate tax rules describe business value in a similar way. They look at a fair appraisal of all assets, including goodwill (the value of a company’s name, customers and reputation). They also look at the business’s demonstrated earning capacity. 26 C.F.R. § 20.2031-3

You can apply these approaches to the whole business. The key person method narrows the question to one person’s effect.

Step 1: Isolate the person’s contribution

Start by listing the work only this person does well. Include these items:

• Duties: sales leadership, technical work, project management or operations the business relies on.
• Client and supplier relationships: which accounts would stay if this person left?
• Technical knowledge: systems, licenses or know-how held by one person.
• Lender relationships: who the bank calls, and who signs.
• Decision authority: who approves pricing, hiring and major contracts.

For each item, note which revenue and cost lines depend on it. Mark the lines that would continue with little change.

Write this list with the owner, your CPA and the leadership team. Gaps are easier to see when more than one person reviews them.

Step 2: Estimate the profit at risk if the person is gone

The profit at risk is the profit that this person’s work supports over a realistic recovery period.

Use recent financial statements. Track profit, not revenue. Revenue shows money coming in. Profit shows what remains after costs. Some costs do not fall when sales drop, so a revenue figure can overstate the loss.

Next, decide how long the business would need to rebuild the lost sales or hire a replacement. Write that period and the assumptions behind it. Someone reviewing the numbers later should be able to see why you chose them.

Buyers and lenders may also value a business lower when so much depends on one individual. Some people call this a key person discount. It reflects the added risk that the person’s absence creates.

Step 3: Add replacement, recruiting and transition costs

Add the one-time costs of replacing the person. Include only the costs that are not already in your profit estimate. Counting a cost twice inflates the total.

Common costs include:

• Recruiting fees
• Training time for a new hire
• Overtime for other staff
• Interim management
• Lower productivity while a successor learns the role

Record each cost with its source, such as an invoice, a pay record or a written estimate. A total you can trace is easier to check later.

Step 4: Account for lenders, buyers and the buy-sell agreement

Lenders, buyers and co-owners can change the financial impact of losing one person. If a loan or credit line depends on one person, the lender may change its terms. Write those terms into your estimate.

A buy-sell agreement sets the price and terms for an owner’s interest when that owner leaves, dies or becomes disabled. The price in that agreement may differ from the figure you calculate, so compare the two.

Florida law also sets rules for insurance on a key person. Under Fla. Stat. § 627.404, a business entity has an insurable interest in the life, body and health of its owners, directors, officers, partners, managers, and key employees or key persons of the entity or of any affiliate or subsidiary, where written consent from the key employees or key persons is obtained before the insurance is purchased. A business entity, or any affiliate or subsidiary of it, may not retaliate or take adverse action against any key employee or key person who does not consent to insurance being issued on that person’s life. The business entity or affiliate or subsidiary may not retaliate or take adverse action against a key employee or key person who does not consent to the issuance of insurance on that person’s life. Under the same statute, an individual party to a contract for the purchase or sale of an interest in any business entity has an insurable interest in the life of each other party to such contract, for the purpose of such contract only.

For how these pieces connect to coverage choices, see our key person insurance guide.

Why rules of thumb fall short in valuing a business

No rule of thumb can tell you what one person is worth to one business. Some people use a multiple of annual profit as a quick guide. A multiple is a starting point for discussion. It does not measure the key person’s role, the business’s risk or its industry.

A business earning $300,000 a year does not have a set value from that number alone. Two businesses with the same profit can carry very different risk. If one depends on a single person and the other does not, the numbers will tell different stories.

Use a rule of thumb, if at all, only as a cross-check after you finish the steps above.

Putting the numbers together and checking them with a CPA

Add the profit at risk to the one-time costs. That gives one working figure.

Then run the numbers twice. Use cautious assumptions once and more optimistic ones once. If the figure changes a lot, the key assumption needs more work.

Tax rules affect the after-tax cost of coverage. The tax code limits some deductions tied to life insurance. Ask your CPA how these rules apply to your ownership and beneficiary setup.

The NAIC Life Insurance Buyer’s Guide covers how much coverage to buy, how to compare policies and the questions to ask before you buy. NAIC Life Insurance Buyer’s Guide

This figure is a planning estimate. It is not an appraisal, and it does not predict what would happen to your business.

To talk through how key person coverage could fit your business, you are welcome to contact us to arrange a coverage review. Contact NR CPAs & Business Advisors