Negotiating risks around key man risk

Last year, I had an interesting chat with the CEO of a large bank in Tanzania about its role in helping family-owned businesses adopt governance standards. Whether it is a bank that has supplied credit to a business, or a manufacturer who has sold product on credit to a distributor, or a wholesaler who has sold goods to a shopkeeper, all these entities are faced with the nerve-wracking hope and prayer that the key man (or woman) does not keel over and die before the loan or goods are paid for in full.

So, rather than the bank sending officials to the funeral to establish that the founder is dead and that they were up the proverbial creek without a paddle, the CEO engaged the founder using the sensitive lever of loan pricing. If the founder appointed his son as a director and gave him active management responsibilities, the bank would reduce the interest rate.

Being an astute businessman, the founder played ball and brought the son on board. Whether he gave him actual responsibilities is another story. But what the bank forced the man to do was to bring his family to the suburbs. To have line of sight over the bright lights and big city that represented his business rather than hear about it from way out there in the village.

Proverbially, of course. If the founder was fatally wounded via a choked chicken bone, at least one person could sign the documents that could ensure business continuity including payment of salaries and repayment of loans.

Here in Kenya, Joe, a distributor of fast-moving consumer goods, supplied Mary with Sh50 million goods on the back of good repayment history. Mary died in a road accident. Joe had extended the credit to Mary on the back of his own credit record with the manufacturer of the goods.

Mary’s spouse was not involved in the running of the business and her managers were in name only. It took a year for Joe to start being repaid as the family looked for her estate administration hum drum.

But he had to pay the manufacturer when the debt was due. So, he was out of pocket for a long time with no recourse to anyone except his own savings to tide the working capital shortfall that Mary’s debt presented.

In the earlier story, the Tanzanian bank CEO had stepped in to forestall what would have been a major crisis if the businessman customer died. The sizeable loan would have gone straight into default. More importantly, the bank drew a line in the sand for many other sole proprietors who had sizeable loans: shape up or ship out.

A number actually left to find other banks that would lend without forcing them to bring annoying wives and children into the business.

There are plenty of banks that are willing to lend to good borrowers who want big loans. After all, part of the loan documentation will be the requirement for the big borrower to buy keyman risk insurance, with the bank as the named and only beneficiary when that chicken bone goes fatally awry.

But the main problem never goes away, that of what happens if the founder is indisposed.

Once a business has survived the first three years of infancy, a growing constituency of stakeholders begins to emerge: employees, customers, suppliers and the indomitable lion also known as the revenue authority. Each has a legitimate stake in the business albeit somewhat hierarchical.

In Joe’s case above, his demands as a supplier came second to those of the Kenya Revenue Authority and could possibly have been knocked to a distant third as employees needed to be paid salaries for past and present work done.

In Joe’s words, “It was a hot mess.” It made him appreciate his own governance structure that he had set up just two years before the event. He had sought an independent chairman and four board members from varied professional backgrounds.

Joe’s board strongly pushed for the creation of a management structure that allowed the business to run whether he was in office or out swimming with dolphins off Wasini Island.

Mary’s death was not a fatal blow to Joe’s business due to his strong cash saving discipline. But it was the shock he needed to start assessing his other large customers from a keyman risk perspective and deciding whether to give credit on that critical risk parameter.

Joe and the Tanzanian CEO are completely aligned on forcing founders to face keyman risk head on.

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Twitter:@carolmusyoka