|Read our article in Construction Executive on Protecting Your Balance Sheet|
The untimely death of a key employee or a business owner who is also a key employee can have a disastrous effect on a business. Some of the "costs" of such an event might include:
- A weakening of the company's credit rating.
- The financial cost (in time and dollars) to find, hire, and train a replacement.
- The distraction of other employees, resulting in deadlines not met, deteriorating
morale, or a higher level of personality conflicts.
- A need for cash to fulfill promises made to the deceased employee's spouse
or family, such as salary continuation or deferred compensation.
- The inability to seize a business opportunity, because cash reserves is
being used to recruit and train the new employee.
- A loss of confidence among both suppliers and customers.
ADDITIONAL PROBLEMS IF KEY EMPLOYEE IS AN OWNER
- Disagreement between heirs and surviving business owners or key employees.
- Lack of cash to buy the interest of the deceased owner, requiring a
sale of the business to an unknown "outside third party."
- Surviving owners may be forced to work with someone who is either not
competent, or not motivated enough to make the business thrive.
- The business may have to be sold to pay estate taxes.
Valuing a Key Employee
There is no easy mathematical formula to determine the value of a key
employee. However, over the years business owners have frequently used
three different methods to estimate the worth of an employee to their company.
- The Multiple of Compensation Method: Assumes that an employee's value
is accurately reflected in his or her total compensation package. The "multiple" that
is used (for example: 2 x annual compensation), will depend on the
type of business and the estimated difficulty in finding a qualified
replacement. This method is perhaps the easiest way to estimate the
potential loss to the firm.
- The Contribution to Profits Method: Estimates the impact a key employee
has on the company's net profit. The firm calculates the expected profit
from a "normal" return on capital, e.g., the net book value of
assets. Profit in "excess" of this normal return is assumed
to result from the efforts of the key employees. An estimate is made
of the percentage of profit attributable to each key employee. This
percentage is then multiplied by total excess profit, to determine
the dollar amount of excess profit from each key employee. This sum
is then multiplied times the number of years needed to find and train
a competent replacement.
- The Cost of Replacement Method: Totals the direct, out-of-pocket costs involved in finding, hiring, and training a replacement, as well as the estimated "loss of opportunity" costs.