206: Evaluating Key Man Risk When Investing

In this week’s episode, Josh Robb and Austin Wilson dive into a crucial topic: key man risk (or key person risk). They break down what this means and why it’s so important for anyone looking to invest wisely. Using examples like Charlie Munger’s recent passing and Warren Buffett’s influence at Berkshire Hathaway, they show how the fate of companies can be tied to the individuals leading them…

 

Main Talking Points

[1:04] – What is Key Man Risk? (& Charlie Munger Talk)

[2:12] – Current Influential Key Man Risk: Warren Buffett

[8:27] – Current Influential Key Man Risk: Elon Musk

[12:19] – Current Influential Key Man Risk: Mark Zuckerberg

[14:38] – Dad Joke of the Week

[15:46] – Does Key Man Risk Matter as An Investor?

 

Links & Resources

Full Transcript

Welcome to the Invested Dads podcast, simplifying financial topics so that you can take action and make your financial situation better, helping you to understand the current world of financial planning and investments. Here are your hosts, Josh Robb and Austin Wilson.

Austin Wilson:

All right. Hey, hey, hey. Welcome back to the Invested Dads podcast, podcast where we take you on a journey to better your financial future. I’m Austin Wilson Co-Portfolio Manager at Hixon Zuercher Capital Management.

Josh Robb:

And I’m Josh Robb, Director of Wealth Management at Hixon Zuercher Capital Management. Austin, how can people help us with our podcast?

Austin Wilson:

We would love it if you’d subscribe if you’re not subscribed, so you get new episodes when they drop on Thursdays, and if you leave us a review on Apple Podcasts or Spotify or wherever you listen, that’d be appreciated because that helps us to be found so we can help more people know about money. So today, Josh-

Josh Robb:

Yes.

Austin Wilson:

… we got an interesting discussion we’re going to have. Today we’re going to be discussing the topic of key man risk.

Josh Robb:

That’s right. Being locked out of a house is a big deal, so you need to know who the key man is.

 

[1:04] – What is Key Man Risk? (& Charlie Munger Talk) 

Austin Wilson:

So key man risk refers to the potential impact that a company’s operations and a company’s value inherently is really tied to their leader. And what would happen if that leader were incapacitated in some way, shape or form-

Josh Robb:

Or left.

Austin Wilson:

Yeah, yeah, they leave. They are unable to actually perform their duties or they pass away as one example we’re going to talk about soon. So, I mean, this is a pretty significant risk when it comes to publicly traded companies specifically. So, what we’re going to be talking about today is, number one, what is key man risk? We just talked about it a little bit, some examples about it and then why it matters when we’re looking at investing in publicly traded companies. Because the leaders in the company play pivotal roles in the decision-making. A lot of times they have very unique expertise, they have a lot of valuable relationships, and they drive a lot of the innovation that we’re seeing in the companies that really contributes to their overall success. So one of the reasons that this came up-

Josh Robb:

Yeah, well, first, a key man unlocks a lot of potential of the company. See what I did there? Oh, man. Been waiting for that.

 

[2:12] – Current Influential Key Man Risk: Warren Buffett

Austin Wilson:

No way, he’s been waiting for that one for a long time. So recently Charlie Munger, a very influential business figure, 99 years old, passed away.

Josh Robb:

Sad.

Austin Wilson:

Really sad. He’s been in the business for a long time. But Warren Buffett’s right-hand man. So they’ve been friends for 50 years. So anyway, he just passed away and that got us thinking a little bit about the topic of key man risk, because obviously Charlie Munger, a very influential figure at Berkshire Hathaway and in the business world. So we decided, hey-

Josh Robb:

Let’s talk about it.

Austin Wilson:

Let’s look at some more examples and discuss the topic of key man risk a little bit. So first of all, let’s start with talking about Charlie Munger. So Charlie Munger, why was he such a key figure for Berkshire Hathaway? And I think let’s dig into that first. So number one, he was often recognized for really having a lot of wisdom. And Warren Buffett has actually referred to him multiple times as being essentially smarter than him. He would go to him for advice and go to him for reasoning and go to him for tips and really understanding of things. So he’s had a lot of wisdom in the investment industry for a long time. They were business partners forever, and a lot of Berkshire Hathaway’s growth really from the ’60s all the way until not that long ago. A lot of those decisions were heavily influenced by Charlie Munger. So one thing that’s interesting is when you’re looking at leadership, not every company has a team where there’s two people that work so closely together, but Berkshire Hathaway certainly has, and they complimented each other very, very well.

And they were able to poke holes in the other’s investment thinking and really form a broad and diverse investment experience exposure and thinking about things over time. So that’s one reason Charlie Munger had some key man risk. Another was that he had some very experienced perspectives on the economy and business cycles. If you’ve ever listened to much of what he said, he’s been very to the point, very direct, very concise and witty, even all the way until ninety-nine years old. Very, very witty in the way he spoke. But that really just I think, brought some clarity to the way that he could easily explain the way he thought and he felt about investments, about the economy, about what’s going on in the markets and the world. And I think that that was a valuable asset for Berkshire Hathaway as their strategically leading that company forward.

And third and finally, one of the interesting factors about him is, he’s just been with Buffett so long that that has ingrained a sense of stability to the leadership of that company, specifically Berkshire Hathaway again. And that extensive decades-long knowledge and experience was a reassuring thing to investors when they were looking at what the company is going to do going forward. So it’s a little bit about why Charlie Munger specifically was such a key man when it comes to the leadership of Berkshire Hathaway. But let’s turn the coin over.

Josh Robb:

Warren Buffett.

Austin Wilson:

A very recognizable name if you’re in the industry, but if you’re not in the industry, you don’t probably have any idea who that is. But Warren Buffett, everyone knows who Warren is.

Josh Robb:

They know that name.

Austin Wilson:

They know the name.

Josh Robb:

I mean, they have large food spreads named after him.

Austin Wilson:

All you can eat Warren Buffet’s everywhere. But a couple factors about why Warren Buffett has key man risk. So he’s really been known for his way of making solid investment decisions over time. He’s more of a traditional value investor, so he’s looking at buying things that are on sale and holding them for a long time.

Josh Robb:

And he literally means buying the company on sale. Yes.

Austin Wilson:

But he actually buys companies.

Josh Robb:

Yes. On sale and holds them.

Austin Wilson:

Exactly, yes. So his investment philosophy and his decisions have really been the cornerstone of why Berkshire Hathaway has been so successful for so long. Again, just being able to identify undervalued companies again, either, whether they’re publicly traded or buying a whole company and holding them for a long-term and really unlocking a lot of value, really contributed to their share price growth over time. Another reason Warren Buffett’s been such a key leader and has some key man risk is, he’s got a really public record of having great respect from people outside the business, inside the business. His shareholders really respect him, his communication, like Charlie Munger’s, very, very good. In fact, his annual letter to shareholders that he writes, something that I would recommend, but they’re very good about what’s going on, not just with Berkshire Hathaway, but with the markets and investing in the economy as a whole. So very, very good.

But he has some influence on market sentiment and obviously Berkshire Hathaway share prices over time have just reflected the confidence in his leadership as well. And on that note, his leadership style and his focus on risk management when it comes to being diverse in his company and what they own and all of that has really, I think, reassured investors that he’s being an ethical leader as well. So he’s looked up as someone you can say, “Hey, I want to invest like him. I want to do business like him.” And that’s really helped the culture around investing in Berkshire Hathaway, been a favorable thing over time. I think that when you look at whether that be Warren Buffett or Charlie Munger, there’s been some key man risk at Berkshire Hathaway, but the question is, what would happen going forward, right?

Josh Robb:

Yeah.

Austin Wilson:

So obviously Charlie Munger just passed away. Warren Buffett, he’s the CEO still, but he’s the key man now. Munger was his second in command, but actually within the last handful of years, the board has brought up this guy named Greg Abel, and he’s actually going to probably be the successor to Warren Buffett as CEO. Because Warren Buffett’s no spring chicken either. He’s what, 94?

Josh Robb:

He’s young. A young 94 years.

Austin Wilson:

He drinks Coke all the time and eats McDonald’s. He’s got a long time to live. But I think they’ve mitigated some of the key man risks by identifying years before anything should happen-

Josh Robb:

Yep, who’s next, where to go?

Austin Wilson:

Who’s next, really? And that this guy’s been running money for Berkshire Hathaway for a long time already, has a lot of experience. So one thing we’re going to talk about when we get to looking at the stock side of key man risk is that companies should plan ahead. You can mitigate some of that risk over time.

Josh Robb:

What they don’t want is for everybody to be surprised. That’s really the thing.

 

[8:27] – Current Influential Key Man Risk: Elon Musk 

Austin Wilson:

Another couple leaders we’re going to talk about that have some key man risk when it comes to how they lead their company. And these are very big names, as I would assume almost everyone knows.

Josh Robb:

These are not recommendations because we’re going to talk about the companies.

Austin Wilson:

We are going to talk about their…

Josh Robb:

But we’re talking about why they’re leaders are a key man risk.

Austin Wilson:

Yeah, and this will relate to their companies. No recommendations on buy seller or hold of these companies at all. Again, talk to your financial advisor. They may have some opinions on this themselves. I have mine and I’m not even going to express them that much, and if I do, Josh is going to hit me.

Josh Robb:

Yep.

Austin Wilson:

So number one, and probably the most famous key man risk in the world, Elon Musk.

Josh Robb:

Yep.

Austin Wilson:

He’s a big deal.

Josh Robb:

He’s a risk.

Austin Wilson:

He’s a risk. So why does he have key man risk? He’s the visionary in his leadership approach. He has a long-term, big vision for Tesla specifically, or SpaceX or whatever that may be. But Tesla is the one we’re going to be focusing on today. But a long-term vision with big growth thoughts in the way he thinks about leading his company, Tesla. So he’s had a lot of innovative ideas in the EV space, electric vehicle space, a lot in the solar space and battery technology. And his vision has really defined the trajectory of green energy for one, and electric vehicles for two, over the last decade or so. And I think that that’s one reason that he’s just influential in the space. And Tesla is the biggest player in the electric vehicle space. So key man risk for sure right there. Number two, this is where it gets a little controversial. So Musk is a very public individual. He does a lot of interviews. He is very active on social media.

Josh Robb:

He has a social media company.

Austin Wilson:

He owns X, I guess now it’s not Twitter anymore. And he uses it very frequently and he gets a lot of pushback for what he says because he speaks his mind. That’s one of the things he liked about X when he bought it, is-

Josh Robb:

He could do that.

Austin Wilson:

… he could do what he wants. But he just has this high profile persona, and that with it carries an opportunity to hopefully explain what you’re doing with the company and some cool new technology and all this stuff, of course. But it also carries with it quite a bit of risk because I think he’s the number one followed person on X, in terms of followers. And so everyone sees everything you tweet and it’s going to be scrutinized. So he’s obviously had some public backlash for some certain things he said many times, most notably, yes, there was some issues with some anti-Semitic discussion recently, but also if we think back a couple of years ago, he got in trouble with the SEC because of some discussions about taking Twitter private-

Josh Robb:

And listing prices.

Austin Wilson:

No, he’s taking Tesla private?

Josh Robb:

Yes, with listing the dollar amounts.

Austin Wilson:

Listing prices for deals that may or may not have actually been happening and clearly moving the stock price. So we’re going to say that’s key man risk, for sure. Because if you say something wrong that gets you in trouble, that can obviously have big implications.

Josh Robb:

Or you put the board in a position where they have to fire you.

Austin Wilson:

Yeah. What if the board fires you and you are the largest shareholder? Because he is the largest single shareholder with all the stock options and shares outstanding as he’s the world’s richest man. Yeah, that’s a risky one. Another one is just, again, the innovation in a product development, Musk is very involved on a day-to-day basis with the actual running of the technology side. A lot of CEOs delegate. Musk, he’s very smart, almost too smart, some people think. But he’s very involved with the day-to-day product development. He’s often spearheading initiatives and pushing the company forward towards some really, really crazy technological advances like autonomous driving. So that’s Elon Musk, I’d say more than a moderate amount of key man risk.

Josh Robb:

For sure.

 

[12:19] – Current Influential Key Man Risk: Mark Zuckerberg 

Austin Wilson:

And last but not least of my examples we’re going to talk about today, there’s obviously a million-

Josh Robb:

A lot of them.

Austin Wilson:

… is Mark Zuckerberg. So Mark Zuckerberg, he’s the CEO, the founder-

Josh Robb:

Meta.

Austin Wilson:

… of Meta. It used to be Facebook, but Meta Platforms is the parent company of the Facebook family of apps. And one thing that is unique, and it can be both a pro or a con, is when you’re the founder of the company, you obviously know it better than anyone. You’ve sent the vision from the beginning as building the initial concept and growing it from there. But also you may not be open to some new ideas which investors may want. So there’s a lot of tension there when you’re the founder and the guy who’s running the company still to this day. So that’s one area of risk potentially, but it’s also an asset to a lot of people. They like to buy founder-led companies for one. Another is that he’s just so integral in the strategic decision-making process, whether that be looking at what acquisitions to make, recently that’s been Instagram, WhatsApp, all these things going into the metaverse is a more recent one.

Josh Robb:

That’s been his big passion.

Austin Wilson:

His big passion.

Josh Robb:

Where some people weren’t as sure, but he’s the leader and that’s where they’re going-

Austin Wilson:

… wasn’t so sure. Third, because Facebook or Meta, depending on what era you’re talking about, is so synonymous with Zuckerberg, him being the leader of the company, it really does add some confidence in how it’s being led, how it’s being driven, what it’s going to look like going forward. And obviously what he says has a big influence on how the company’s share price moves. So he’s very influential in that. And then he also, just like Musk, very influential in the new direction and the foray the company’s going into. You mentioned it with the metaverse, that’s his baby. He wants to grow that and make that really the biggest part of the company eventually. But Wall Street’s not quite so certain about that.

Josh Robb:

It could be virtually the biggest part of his company.

Austin Wilson:

It could be virtually the biggest part of the company. But there’s a lot of involvement there. So Zuckerberg obviously has his own levels of key man risk as well. So all of these leaders among many others, they’re key leaders in their companies for a reason. But if something were to happen where they get in trouble or they get sick or they pass away in Munger’s case, that can cause some uncertainty as it relates to these companies.

 

[14:38] – Dad Joke of the Week 

Josh Robb:

All right, we’re going to take a quick break before we get back to, well, why does key man risk even matter as an investor? But before we do, I got a dad joke and it’s a little bit of a story just for you.

Austin Wilson:

Boo, bring it.

Josh Robb:

All right. So a while back I drank some invisible ink. Yeah, I had to go to the emergency room, but it took me a while to be seen there in the emergency room. Yeah, it’s a long wait.

Austin Wilson:

That’s a long wait.

Josh Robb:

I know.

Austin Wilson:

Oh man.

Josh Robb:

That’s what I got for you.

Austin Wilson:

Have you made the invisible ink with lemon juice?

Josh Robb:

Yeah, as a kid. Not with lemon juice, but you had invisible ink. We had a little thing, it was a spy kit or whatever. And I remember, was probably fine, you didn’t drink it, I didn’t drink it, but you’d write it out and then it shows up. I don’t know. It’s interesting. It’s cool.

Austin Wilson:

I’ve never written anything in invisible ink, but I’ve seen it, the lemon juice thing, just, you can write anything you want.

Josh Robb:

Closest I do every year is during Easter, when you’re doing Easter eggs, if you use the clear, just the wax crayon, and then when you dunk it, then it just keeps the dye off of the egg. So that’s kind of like the reverse invisible ink stuff.

Austin Wilson:

It’s reverse, it’s tie-dye from eggs.

Josh Robb:

That’s right.

 

[15:46] – Does Key Man Risk Matter as An Investor? 

Austin Wilson:

All right, so you brought it up already, but why does key man risk matter as an investor? Because it certainly does. We wouldn’t be talking about it if it didn’t. So, it really matters because investors need to be able to discern and assess the company’s stability and the potential for growth really based on their key leaders and their vision for the company and where they’re taking companies. So there’s four different ways that this is really important, as it relates to thinking about the leadership pertaining to the stock we’re investing in. So, number one, a company’s leadership really in regards to its CEO or even other key executives, often defines strategic direction and strategic direction drives forecasts, it drives stock prices. And if a key person, one of those key leaders leaves suddenly due to the health issue, retirement, whatever other reason that could be death, it might disrupt the company’s vision, it might disrupt their strategy, which can cause some uncertainty.

So that’s a big risk for one. Need to get your mind around where the company’s going. Number two, key individuals might really have specialized skills, relationships that are really critical to the company’s day-to-day operations or their growth. So this could be in regards to a key scientist in a pharmaceutical company. They might be the driving force behind developing a new drug, or in the software world, writing a new software. It could be the AI spearhead.

Josh Robb:

Or in the investment world, if you’re investing in a mutual fund, that key manager would be an example of that. They’re the ones that have the philosophy and the process. They’re the ones that come up with the investment ideas. That’s another way where there’s a key man, we didn’t talk much about it, but in a fund or any investment portfolio that’s being managed, that key person who’s running it could be a risk.

Austin Wilson:

Yeah. So, when you lose potentially that individual or that group of individuals, that expertise that you’re taking away could delay projects. It could affect the company’s competitive edge. Maybe they’re weaker compared to their peers at that point. Number three, investor confidence is something we have already talked about, but investors often view key man risk as a factor that could affect a company’s stability. So, a sudden departure or incapacitation of a key figure could lead to a drop in confidence, which would cause a drop in…

Josh Robb:

Price.

Austin Wilson:

Stock price. And stock, I mean, when you’re a publicly traded company, the board is there to ensure that the company is trying to maximize shareholder return.

Josh Robb:

That’s right.

Austin Wilson:

That is what they’re there for, maximizing shareholder return. And if investors aren’t confident and share price is going down, that’s not maximizing their return.

Josh Robb:

Nope.

Austin Wilson:

So we want confidence. And number four, succession planning. Companies with a strong succession plan might mitigate this risk. So if you’ve established that, “This person’s my second in command and when I retire, they’re going to take over and just lay it out very, very clearly early on,” That can mitigate some of the key man risk. Especially if the person that’s next in line is a very groomed, very suitable replacement with a lot of experience, it can reassure investors and minimize the impact of the actual departure. And I think that’s something that we’re actually seeing playing out in the Berkshire Hathaway story. The Greg Abel announcement happened a couple years ago. Obviously Buffett and Musk… I’m getting all my key man-

Josh Robb:

They’re all together. Munger.

Austin Wilson:

… mixed up here. Buffet and Munger have worked together for a long time, but Abel’s been working with them as well. So there’s a bit of a transition and a layout of that plan going forward already. But one thing we need to keep in mind as investors is, when we assess this key man risk, it’s part of our overall evaluation of the company’s management and their leadership quality. And we want to buy companies, buy shares in companies that we trust the leadership, that we know what is going to happen. It might not always have immediate negative consequences if something were to happen, but sometimes it does. And we need to be prepared for that if and when that does happen. So like I mentioned earlier, it’s very important for these companies, publicly traded companies specifically, but private companies as well, to have plans in place. Have succession plans in place, have a written plan that if some of these unfortunate scenarios were to play out-

Josh Robb:

This is what happens.

Austin Wilson:

… we know what’s going to happen. And that’s going to reassure clients, that’s going to reassure investors, employees too.

Josh Robb:

Oh, yeah. Overall, when we look at this, the idea should be, it shouldn’t stop you from considering a company if you think there’s a big important person that drives a lot of that, but you should factor that in when making those considerations. And in the end, for businesses, there’s always going to be those important people, which is why in our industry there’s insurance that companies take out on behalf of key employees. And the whole point is just that, it will be a disruption, but can we find ways to mitigate and minimize that disruption? So that’s really what you’re looking for.

Austin Wilson:

Yeah, like you said, it’s not necessarily a reason. Just because there’s a key individual does not mean you should not buy that. It’s just another level of something to be aware of as you’re evaluating companies. That’s key man risk in a nutshell, definitely brought to our attention as we were thinking about this whole Charlie Munger passing unfortunately. But something to keep our minds around as we’re looking at investments and looking at the markets. But thanks for listening. And please remember if you had someone asking, “Hey, what does this Munger thing have to do with Berkshire Hathaway stock? Or is it going to tank it?” I don’t know, maybe send this episode. They may be able to learn a little bit more about key man risk. Always feel free to email us any ideas you have to below hello@TheInvestedDads.com and we would love to hear from you, go from there. And otherwise, until the next episode, have a great one.

Josh Robb:

Talk to you later.

Austin Wilson:

Bye.

Thank you for listening to the Invested Dads podcast. This episode has ended, but your journey towards a better financial future doesn’t have to. Head over to TheInvestedDads.com to access all the links and resources mentioned in today’s show. If you enjoyed this episode and we had a positive impact on your life, leave us a review. Click subscribe and don’t miss the next episode.

Josh Robb and Austin Wilson work for Hixon Zuercher Capital Management. All opinions expressed by Josh, Austin or any podcast guest are solely their own opinions and do not reflect the opinions of Hixon Zuercher Capital Management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Hixon Zuercher Capital Management may maintain positions in the securities discussed in this podcast. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principle. There is no assurance that any investment plan or strategy will be successful.