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Tagged: Discount, Key Employee, Valuation
Kathleen ReynoldsKeymasterOctober 23, 2022 at 1:49 pmPost count: 428
Determines the value of a key (essential) employee to a business by taking a discount from the full value of the business and then showing the value of the business without the key employee.
Often, the loss of a key employee adversely affects the earning potential (and sometimes the stability) of a business. Closely held corporations are especially vulnerable as their profits rely on the ability, initiative, and business connections of one employee or a small group of employees.
A common method of calculating the economic effect of the loss of a key employee is the discount approach. This approach applies a percentage discount to the fair market value of the business.
The discount approach requires an appropriate discount factor. Some authorities believe that if the business will survive the loss of the key employee and, in time, will hire a competent replacement, an appropriate discount factor is 15 to 20%. If the business will fail, or will be placed in jeopardy from the loss of the key employee, an appropriate discount factor is 20 to 45%. The officers of the company and the firm’s accounting and legal advisors, however, should determine the exact discount factor. Consider the following when determining the discount factor:
- How long will it take the replacement to become as efficient as the lost key employee?
- How much will it cost to locate, situate, and train a replacement? Will the new employee want a higher salary?
- Is the replacement likely to make costly mistakes during the training period?
- Will the loss of the employee result in a loss of clientele?
- What percent of the firm’s current net profits is attributable to the key employee?
While there are other methods of calculating the value of a key employee’s contribution to a corporation, the discount approach is a quick and effective method that sidesteps many of the difficulties posed by alternative methods.
- Fair Market Value of Business With Key Employee: Enter the current market value of the business.
- Discount Without Employee: Enter the discount to be applied to the market value of the business. This discount reflects the financial loss to the business caused by the key employee’s death or disability.
The program displays the value of a key employee to a business and the value of the business without the key employee. The calculation determines the “value of key employee” by multiplying a specified discount percent by the full value of the business. This discount percent reflects the economic loss the business will suffer upon the loss of the key employee. The calculation then subtracts the value of the key employee from the value of the business to arrive at the “value without key employee.”
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