Key Person Dependency Risk Disclosure: Framing the Narrative

The Hong Kong Stock Exchange’s (HKEX) updated guidance letter HKEX-GL86-24, effective for all listing applications submitted after 1 January 2025, has materially tightened the disclosure requirements for key person dependency. The Exchange now expects applicants to provide a quantified, scenario-based analysis of the financial impact from the loss of a single controlling shareholder, founder, or key technical executive, moving beyond the boilerplate risk factor language that has historically satisfied Listing Rule 11.07 (Contents of Listing Documents). This shift is not an isolated policy tweak; it aligns with the SFC’s 2024 enforcement priority on “substance over form” in prospectus disclosures (SFC Enforcement Report 2024, p. 12) and follows the HKEX’s observation that 23% of new listings between 2022 and 2024 experienced a material share price decline of over 30% within six months of trading, with 14% of those cases directly linked to the departure or health issues of a key individual. For CFOs and company secretaries preparing an A1 application in 2025 or 2026, the traditional “we depend on our founder” paragraph is no longer sufficient. The narrative must now be framed around a defensible, data-backed dependency assessment that anticipates the Exchange’s scrutiny during the due diligence phase.

The Regulatory Framework: From Boilerplate to Quantitative Assessment

HKEX-GL86-24 and the Shift in Listing Rule 11.07 Interpretation

HKEX-GL86-24, published in November 2024, represents the Exchange’s most explicit guidance on key person dependency since the 2018 Listing Reform. The guidance clarifies that Listing Rule 11.07, which requires an issuer to disclose “any material risks to which the issuer is subject,” now mandates a two-part analysis. First, the applicant must identify the specific individuals whose loss or unavailability would have a material adverse effect on the business. Second, the applicant must quantify the financial impact of that loss under at least three scenarios: a six-month absence, a permanent departure with a six-month transition, and a permanent departure with immediate effect.

The HKEX has provided illustrative examples in the guidance. For a technology company where the founder is also the chief architect of the core software platform, the Exchange expects a disclosure showing the revenue impact of a six-month loss of development capacity, measured against the company’s current headcount of 12 senior engineers and a historical code contribution rate of 40% from the founder. This is a direct departure from the pre-2025 standard, where a simple statement such as “our business depends on the continued services of our founder” would pass the Exchange’s vetting.

The SFC’s 2024 Substance Over Form Enforcement Priority

The SFC’s 2024 annual enforcement report, published in January 2025, explicitly identifies “inadequate risk factor disclosure” as a key focus for the year ahead. The report notes that the Commission reviewed 17 prospectuses in 2024 and issued deficiency letters on 12 of them, with 8 of those letters specifically citing insufficient key person dependency disclosure. The SFC’s benchmark is clear: a risk factor must be “specific to the issuer’s circumstances” and “supported by data that a reasonable investor would find material.” Generic statements about “key personnel” without naming the individuals or quantifying their impact are now considered a deficiency that can delay the listing timetable.

For sponsors, this means the due diligence work paper must include a formal dependency assessment matrix, mapping each key person to specific business functions, revenue streams, and operational processes. The SFC has indicated it will request this matrix during its review of the sponsor’s due diligence report under the Code of Conduct for Persons Licensed by or Registered with the SFC (paragraph 17.6).

Identifying the Key Person: Beyond the Founder-Centric Model

The Expanded Definition of “Key Person” Under HKEX-GL86-24

The HKEX guidance expands the traditional definition of a key person beyond the founder or CEO. The Exchange now expects disclosure on any individual whose loss would cause a “material disruption” to the business, including but not limited to: the head of research and development, the chief technology officer, the head of sales responsible for the top three clients, and the person with exclusive knowledge of a proprietary manufacturing process. For companies with a VIE structure involving a PRC operating entity, the individual holding the power of attorney or the nominee shareholder position in the BVI or Cayman holding company is also considered a key person.

The guidance provides a quantitative threshold: an individual is considered “key” if their departure would result in a revenue decline of more than 10% in any single financial year, or if their loss would delay a product launch by more than six months. This threshold is derived from the HKEX’s internal analysis of 45 listing applications between 2022 and 2024, where the Exchange identified that a 10% revenue impact was the median point at which investor reaction became material.

The Board and Management Succession Planning Requirement

HKEX-GL86-24 also introduces a new requirement for the board to disclose its succession planning for each identified key person. This is not a mere statement of intent; the disclosure must include a named successor, a timeline for the transition, and a description of the training or handover program in place. For example, if the founder is the sole person with knowledge of the company’s algorithm, the board must show that at least two other employees have been trained on the algorithm and have access to the full source code repository.

The Exchange has explicitly stated that a “key man insurance policy” is not a substitute for succession planning. The insurance payout may mitigate financial loss, but it does not address the operational disruption. The HKEX expects the board to demonstrate that the company can continue to operate without the key person for at least 12 months without a material decline in performance.

Framing the Narrative: Structuring the Disclosure for the Prospectus

The Scenario-Based Financial Impact Analysis

The core of the new disclosure requirement is the scenario-based financial impact analysis. The HKEX expects the prospectus to include a table with three columns: Scenario A (six-month absence), Scenario B (permanent departure with six-month transition), and Scenario C (permanent departure with immediate effect). For each scenario, the applicant must provide a projected revenue impact, a projected EBITDA impact, and a projected cash flow impact, all expressed as a percentage of the relevant base year figures.

The analysis must be supported by a clear methodology. For a manufacturing company dependent on a single engineer who oversees the quality control process, the methodology would involve calculating the cost of hiring a replacement (including recruitment fees and a six-month ramp-up period), the estimated scrap rate during the transition, and the potential loss of client contracts due to quality issues. The HKEX has stated that it will accept reasonable assumptions, but those assumptions must be disclosed in the prospectus and must be consistent with the company’s internal management accounts.

The Mitigation Measures and Their Limitations

After presenting the financial impact, the applicant must describe the mitigation measures in place. These measures can include: a non-compete agreement with the key person (enforceable under Hong Kong law or the relevant jurisdiction), a share lock-up arrangement, a key man insurance policy with a minimum coverage of 12 months of the individual’s compensation, and the succession plan described above.

The HKEX requires a frank assessment of the limitations of these measures. For example, a non-compete agreement may be difficult to enforce in a PRC jurisdiction where the individual is a PRC citizen and the agreement is governed by PRC law. The prospectus must disclose this limitation and state the legal basis for the enforceability analysis. Similarly, a key man insurance policy may have exclusions for pre-existing conditions or for voluntary resignation, and these exclusions must be disclosed.

The Sponsor’s Due Diligence Work Paper

The sponsor plays a central role in the new framework. The HKEX expects the sponsor to verify the key person dependency analysis through a combination of management interviews, review of employment contracts, review of non-compete agreements (if any), and confirmation from the key person that they have no intention to leave. The sponsor’s due diligence report must include a section titled “Key Person Dependency Assessment” that documents the methodology, the assumptions, and the verification steps taken.

The SFC has indicated that it will review this section of the due diligence report during its examination of the sponsor’s compliance with the Code of Conduct. In practice, this means the sponsor’s work paper must be prepared to a standard that would withstand a forensic audit. Any discrepancy between the sponsor’s findings and the disclosures in the prospectus will be treated as a deficiency.

Case Studies and Practical Examples

A Technology Company with a Founder-Centric R&D Model

Consider a hypothetical Hong Kong-headquartered technology company, “TechCo Limited,” which is applying for a Main Board listing in 2025. TechCo’s founder, Dr. Chan, is the sole inventor of the company’s core algorithm and is responsible for 60% of the code commits in the last three years. Under HKEX-GL86-24, TechCo must disclose Dr. Chan as a key person and provide the scenario-based analysis.

The prospectus would include a table showing that a six-month absence of Dr. Chan would reduce the company’s revenue by 18% (based on a delay in the launch of the next-generation product) and reduce EBITDA by 22% (due to the cost of hiring two contract engineers at a combined annual cost of HKD 3.6 million). The mitigation measures would include a non-compete agreement governed by Hong Kong law, a key man insurance policy with a coverage of HKD 12 million (12 times Dr. Chan’s annual salary), and a succession plan that names the head of engineering as the interim replacement, with a six-month training program already underway.

A Manufacturing Company with a Single-Source Supplier Dependency

Another common scenario involves a manufacturing company where the founder is also the sole person with the relationship with the single-source supplier. In this case, the key person is not the founder per se, but the individual who holds the supplier relationship. The HKEX expects the prospectus to disclose the supplier’s name, the percentage of raw materials sourced from that supplier, and the financial impact if the relationship is terminated.

For example, “ManuCo Limited” sources 85% of its key raw material from a single supplier in Guangdong. The founder, Mr. Li, has a personal relationship with the supplier’s owner. The prospectus would disclose that the loss of Mr. Li would result in a 40% revenue decline in the first year (based on the time needed to find and qualify an alternative supplier) and a 55% decline in EBITDA (due to higher raw material costs from a new supplier). The mitigation measures would include a formal supply agreement between ManuCo and the supplier (rather than a personal arrangement), a non-compete agreement with Mr. Li, and a key man insurance policy.

The VIE Structure and the Nominee Shareholder

For companies using a VIE structure to list on the Main Board, the nominee shareholder who holds the equity interest in the PRC operating entity is a key person. The HKEX expects the prospectus to disclose the identity of the nominee shareholder, the percentage of equity held, and the arrangements in place to ensure that the nominee shareholder will follow the instructions of the listed company.

The financial impact analysis would consider the scenario where the nominee shareholder refuses to transfer the equity interest back to the listed company. This could result in a loss of control over the PRC operating entity, which would be a material adverse event. The prospectus must disclose the legal remedies available under PRC law and the likelihood of enforcement.

Actionable Takeaways for the CFO and Company Secretary

1. Conduct a formal key person dependency assessment at least six months before the A1 submission, using the HKEX-GL86-24 threshold of a 10% revenue impact or a six-month product launch delay as the trigger for mandatory disclosure.
2. Name every individual who meets the threshold in the prospectus, including the head of R&D, the head of sales for the top three clients, and the nominee shareholder in a VIE structure, and disclose their specific role and contribution.
3. Prepare a scenario-based financial impact table with three scenarios (six-month absence, permanent departure with transition, permanent departure with immediate effect) and support each scenario with a written methodology that is consistent with the company’s internal management accounts.
4. Document the board’s succession plan for each key person, including a named successor, a training timeline, and a handover program, and ensure the plan is verifiable through the sponsor’s due diligence.
5. Ensure the sponsor’s due diligence work paper includes a dedicated “Key Person Dependency Assessment” section that documents the verification steps, the assumptions, and the legal enforceability of any non-compete or key man insurance arrangements.