The Founder's Favorite - How Informal Hierarchies Can Erode Exit Value

Many organizations develop them over time. The employee who “really runs things” despite a title that suggests nothing of the sort. The person founders consult before making significant decisions, whose informal influence may exceed that of executives with corner offices, and whose departure could create disruption no org chart would predict. When buyers encounter these dynamics during due diligence, they often interpret them as transition risk requiring careful evaluation.

Executive Summary

Informal hierarchies represent a frequently overlooked consideration in privately held business valuations. When founders bypass formal management structures to rely on trusted lieutenants, they may create organizations that function on relationships rather than systems—a distinction that can affect negotiations at the closing table.

Buyers conducting due diligence often identify these shadow power structures. They may recognize that the person everyone “just knows” to consult isn’t documented anywhere, that decisions flow through informal channels that might not survive ownership transition, and that the org chart in the conference room bears limited resemblance to how work actually gets done. This gap between formal structure and operational reality can represent transition risk that sophisticated buyers factor into their valuations and deal structures.

The challenge extends beyond simple documentation. Informal hierarchies often exist because they work, at least for the current owner. The founder’s trusted advisor typically earned their influence through competence, loyalty, and institutional knowledge accumulated over years. Addressing these relationships can feel like organizational surgery without anesthesia. Yet discovering during due diligence that your business depends heavily on relationships that may not transfer can prove more painful.

This article provides a framework for identifying informal power structures, evaluating their potential impact on transferable value, and determining whether to formalize the authority they represent or reduce the dependencies they create. The goal isn’t organizational purity but rather building a business that buyers can evaluate with confidence.

Introduction

We recently worked with a manufacturing business owner preparing for exit who was confident his management team was solid. The org chart showed clear reporting lines, defined responsibilities, and appropriate spans of control. On paper, the business appeared professionally managed.

Then we spent a day observing operations.

Many significant decisions seemed to route through Maria, officially the “Executive Assistant” but functionally operating with considerable influence. Production managers often checked with Maria before implementing schedule changes. The CFO sometimes ran financial projections by Maria before presenting them to the owner. Even the VP of Sales, a 20-year industry veteran, occasionally sought Maria’s input on major account strategies. The owner had created what amounted to a shadow executive role, perhaps without fully recognizing what he’d built.

When we raised this observation, the owner’s response was revealing: “Maria just knows how I think. She saves everyone time by filtering out ideas I’d never approve.”

This statement captures both why informal hierarchies develop and why they can affect exit value. They emerge as efficiency mechanisms, reducing friction by concentrating institutional knowledge in trusted individuals. But what feels like efficiency to the founder may look like uncertainty to a buyer. The knowledge that makes Maria valuable is partially dependent on her relationships and context. Some can be documented and transferred, but some is relationship-based and harder to transfer. This uncertainty about what capabilities survive the transition is why informal hierarchies often draw buyer scrutiny.

The question of informal hierarchies affects businesses across industries, though manifestation varies significantly. Professional services firms may operate differently than manufacturing or retail businesses, where decision-making norms and organizational cultures create distinct patterns. Based on our firm’s experience across approximately 40 transactions over the past decade, these dynamics appear common in mid-market businesses where growth has strained founder decision-making capacity but formal structures haven’t yet fully matured. Understanding these dynamics, and knowing when they require intervention versus when they can be managed through other approaches, is essential for exit-focused owners.

The Anatomy of Informal Power Structures

Understanding how informal hierarchies develop helps explain why they can be difficult to address. These structures rarely emerge from conscious decision-making. Instead, they grow organically from founders solving immediate problems without considering long-term organizational implications.

The Trust Premium

Founders operate in environments of uncertainty and limited information. Building a business requires making countless decisions with incomplete data, and the consequences of poor decisions fall directly on the owner. Trust becomes invaluable. Finding someone whose judgment aligns with yours, who understands your priorities without lengthy explanation, and who can be relied upon to act in the business’s interest represents a genuine advantage.

The challenge arises when this trust translates into informal authority without corresponding formal accountability. The trusted advisor becomes the gatekeeper, the person through whom information and decisions flow. What begins as consultation may evolve into effective approval authority. The founder may stop making certain decisions altogether, confident their proxy will handle things appropriately.

The Efficiency Trade-off

Informal hierarchies often deliver genuine short-term efficiency. When Maria already knows the founder’s preferences, why spend time explaining priorities to formal managers who might misunderstand? When the founder’s longtime confidant can resolve interdepartmental disputes quickly, why endure lengthy formal processes? These efficiency gains reinforce the informal structure, making it central to the organization’s operations.

But efficiency and transferability can operate on different axes. The shortcuts that accelerate decisions today may create dependencies that complicate transitions tomorrow. Interactions that bypass formal channels represent processes that haven’t been documented, decision frameworks that exist primarily in relationships, and capabilities that may be difficult to maintain if key people leave.

The Recognition Gap

Perhaps the most challenging aspect of informal hierarchies is how invisible they can become to those who created them. Founders may stop seeing the informal structure as unusual because it’s simply “how we do things.” The executive assistant with effective influence over decisions isn’t viewed as organizational complexity, she’s just doing her job well. The production supervisor everyone consults before implementing changes isn’t a bottleneck, he’s a trusted resource.

This recognition gap means informal hierarchies often surface during due diligence rather than during exit preparation. Buyers, approaching the organization without historical context, may immediately notice when actual authority doesn’t match formal structure. They ask questions founders may not have considered: “Why does everyone seem to check with your assistant before proceeding?” “Why does your org chart show this person reporting to that person when several employees tell us the reporting relationship functions differently in practice?”

How Buyers May Identify Informal Hierarchies

Experienced buyers, particularly institutional investors and PE-backed acquirers, have developed methods for detecting shadow power structures. Understanding these approaches helps sellers appreciate why informal hierarchies often become visible during due diligence. But buyer sophistication varies dramatically. Many smaller financial buyers or strategic acquirers without formal diligence infrastructure may not identify or penalize informal hierarchies at all.

Interview Triangulation

Due diligence teams typically conduct interviews across organizational levels, asking seemingly simple questions: “Walk me through how you’d handle this type of decision.” “Who would you consult before implementing this change?” “If you needed quick approval for something, where would you go?”

The answers reveal actual workflows rather than documented procedures. When multiple employees independently describe routing decisions through the same informal channel, buyers note the discrepancy. When formal managers acknowledge they’d check with someone outside their reporting line before acting, buyers recognize the informal structure.

Decision Archaeology

Buyers may examine past decisions, tracing how they were made rather than just their outcomes. Email trails, meeting minutes, and document histories can reveal who was consulted, whose input shaped final decisions, and whose approval was required at each stage. This archaeology often exposes influence patterns that differ from formal org charts.

Some acquirers specifically request communication pattern data to identify unusually high message volume between the founder and employees at various levels, which can signal informal hierarchies worth investigating.

Scenario Testing

Experienced buyers often pose hypothetical scenarios during diligence: “If this problem arose and the owner wasn’t available, how would it get resolved?” The answers reveal whether the organization has genuine distributed authority or depends on specific relationships to function. Hesitation, references to individuals outside formal leadership, or admissions that certain decisions would simply wait for the owner’s return can indicate dependencies worth exploring.

Strategic buyers focused on integration may view informal hierarchies differently than financial buyers planning management continuity. A PE firm intending to retain existing management may be less concerned about informal structures than a strategic acquirer planning to merge operations. Understanding your likely buyer profile helps calibrate how much weight to place on informal hierarchy concerns.

How Informal Hierarchies May Be Associated with Value Impact

When informal hierarchies become visible during due diligence, they may be associated with valuation impact through several mechanisms. The magnitude of impact varies considerably based on deal size, buyer type, and the specific nature of the informal structures involved. Informal hierarchies often co-occur with other organizational maturity issues: limited documentation, key person dependencies, and founder-centric decision-making. This makes it difficult to isolate their specific impact on valuation.

Transition Risk Considerations

Buyers often factor perceived transition risk into their valuation models. Informal hierarchies can increase this risk by concentrating organizational functions in relationships rather than systems. If key relationships don’t survive the ownership transition, whether through departure, diminished influence, or inability to replicate dynamics with new ownership, the organization may lose capabilities that formal structure never captured.

The actual impact depends on many factors: whether informal power holders are willing to stay post-acquisition, whether their knowledge can be documented, and whether the buyer’s integration approach preserves or disrupts existing relationships. Financial buyers who plan to retain management may view informal hierarchies differently than strategic buyers planning full integration.

Earnout Considerations

Sellers sometimes accept earnout provisions to bridge valuation gaps, receiving deferred payments contingent on post-acquisition performance. Informal hierarchies can make earnouts more vulnerable if the capabilities enabling historical performance depend on relationships that change after closing.

When organizational function relies heavily on the founder’s relationships with informal leaders, performance may decline after closing if those dynamics shift. The founder, now operating within the acquiring company’s structure, may find it difficult to maintain the same decision-making patterns. Informal power holders, sensing changed authority dynamics, may depart. These outcomes aren’t inevitable, but they represent risks that both parties should consider when structuring earnouts.

Deal Structure Implications

Beyond headline valuation, informal hierarchy concerns can influence other deal elements. In transactions where buyers have identified significant informal dependencies, we’ve observed extended holdback provisions, longer founder transition periods, retention agreements with key employees, and earnout structures weighted toward metrics that could be affected by informal hierarchy disruption.

In one engagement we advised, a manufacturing business with approximately $8M in revenue, informal hierarchy concerns contributed to an 18-month extension of the required transition period and shifted a significant portion of the purchase price (approximately 30% in this case) into earnout provisions. This was one transaction with specific circumstances, not necessarily representative of typical outcomes, and the business had multiple overlapping informal structures that amplified buyer concerns. Other transactions we’ve observed show much more modest adjustments. The example illustrates how these issues can affect deal structure, but individual outcomes vary dramatically based on buyer type, competitive dynamics, and the severity of the informal dependencies identified.

When Informal Hierarchies Require Attention—And When They Don’t

Before launching into remediation, owners should assess whether their specific informal hierarchies actually require intervention. Not every informal power structure damages exit value, and formalization efforts carry their own costs and risks.

Situations Where Intervention May Not Be Necessary

Informal hierarchies don’t automatically require remediation in several circumstances:

• The informal power holder is committed to staying 2-3 years post-acquisition. If their continued presence is contractually secured and personally motivated, the relationship-based authority may transfer effectively.

• The role and authority are explicitly documented. Even if formally titled as something else, clear documentation of actual responsibilities reduces buyer uncertainty.

• The buyer understands and accepts the dynamic. Some buyers, particularly financial investors planning minimal integration, may prefer maintaining working relationships rather than forcing formalization.

• The business can demonstrate stable performance independent of any single person. If the informal leader has taken extended absences without operational disruption, the dependency may be less severe than it appears.

In these cases, working with your advisor to manage buyer expectations may be preferable to organizational disruption. The goal is ensuring buyers understand what they’re acquiring, not achieving some idealized organizational state.

Situations Where Intervention Is Warranted

Conversely, informal hierarchies merit serious attention when:

• The influence derives primarily from founder relationship rather than transferable competence
• The informal structure creates genuine bottlenecks that slow decision-making
• Critical decisions consistently bypass formal review processes
• The informal power holder shows resistance to documentation or accountability
• Multiple buyers have expressed concern during preliminary discussions
• The dependency clearly couldn’t survive the power holder’s departure

The key question is whether the informal structure represents genuine capability worth preserving or problematic dependency requiring remediation.

Surfacing Hidden Dependencies

The first step toward addressing informal hierarchies is acknowledging they exist. This requires honest assessment using approaches that reveal actual versus documented authority.

The Shadow Org Chart Exercise

Gather your formal management team and ask each person to independently diagram how decisions actually get made. Who do they consult? Whose input matters? Who can accelerate or block initiatives? Compare these diagrams to your formal org chart, noting every discrepancy.

This exercise often reveals informal power concentrations that formal structure obscures. The marketing manager who technically reports to the VP of Sales but actually coordinates closely with the founder’s assistant. The operations supervisor whose formal authority extends to a single department but whose informal influence spans the production floor.

Completing this exercise typically requires 4-6 hours of management time spread across a few weeks, though this varies based on management team size and organizational complexity. Smaller teams with straightforward structures may complete it in less time. Larger organizations with multiple locations may require more. The timeline of 30 days is achievable for most organizations, though competing priorities may extend this.

Decision Audit

Select 20-30 significant decisions from the past year and trace their actual decision path. Who was involved? Whose input shaped the outcome? Where did formal approval authority reside versus actual approval authority?

This sample size provides an initial scan of decision-making patterns. If the patterns aren’t clear from this sample, expand to 50+ decisions to confirm or refute initial observations. Document specific examples where decisions bypassed formal channels, noting patterns in who gets consulted regardless of formal role.

The Departure Scenario

For each key function, ask candidly: if this person were unavailable for an extended period, how would we handle their responsibilities? The honest answer reveals whether capability resides in documented systems or primarily in relationships.

When the answer involves consulting specific individuals outside formal succession plans, or acknowledges that certain decisions would simply wait, you’ve identified a potential informal hierarchy dependency worth evaluating.

Formalization Strategies

Once informal hierarchies are surfaced, owners face a strategic choice: formalize the authority, reduce the dependency, or accept and manage the risk. The right approach depends on specific circumstances.

When Formalization Makes Sense

Informal hierarchies merit formalization when:

• The person has genuinely exceptional competence not easily replaced
• Their influence spans multiple departments or functions
• They have capacity to handle an expanded formal role with its accountability
• Formalizing creates a logical organizational structure

In these cases, the executive assistant who functions as chief of staff should perhaps become the chief of staff. The production supervisor everyone consults should have formal authority matching their actual influence.

This alignment requires more than title changes. Compensation must reflect the expanded role. Reporting relationships must be clarified. Decision rights must be documented. The informal power holder must understand that their influence now carries formal accountability, and that formal accountability means their authority can survive ownership transition rather than depending solely on founder relationships.

Process Documentation

Informal hierarchies sometimes develop because formal processes don’t exist or don’t work effectively. The founder’s trusted advisor becomes the decision pathway because no other pathway functions as well. Remediation may require building processes that work as effectively as the informal relationships they supplement.

Document the decisions currently flowing through informal channels. Create formal approval matrices specifying who can authorize what. Establish escalation procedures that don’t depend exclusively on informal relationships. Test these processes while the founder is still present to validate they function without informal intervention.

The goal is not to eliminate informal consultation. Founders should still seek judgment from trusted advisors. But critical decisions need formal review even when informal channels exist. Informal consultation plus formal approval typically represents the optimal balance. Informal consultation that bypasses formal approval entirely represents the problematic pattern.

Gradual Authority Transfer

Sudden changes to informal hierarchies often fail because the organization hasn’t developed alternative capabilities. Instead, consider a phased transition that builds formal capacity while gradually reducing exclusive dependency.

Start by having informal power holders document their decision frameworks. What factors do they consider? What priorities guide their choices? This documentation makes tacit knowledge more explicit and potentially transferable.

Next, have formal authority holders observe the informal decision process, understanding how decisions actually get made. Then shift the dynamic, with formal authorities making decisions while informal power holders provide coaching. Finally, establish that formal approval is required even when informal consultation occurs.

Based on our firm’s experience with organizational transitions, this process often takes 12-24 months, though heavily founder-dependent businesses or those with multiple overlapping informal structures may require 24-36 months or longer. Several obstacles commonly arise: formal authorities require 3-6 months of observation to internalize decision frameworks, formal and informal authorities may subtly compete for influence during transition, employees often revert to informal channels if new authorities don’t demonstrate equivalent decisiveness, and some informal knowledge proves impossible to fully systematize. Planning for these obstacles explicitly improves outcomes.

When Formalization Efforts Fail

Not all formalization efforts succeed, and owners should understand common failure modes before committing significant resources.

Resistance from informal power holders. The person whose authority you’re formalizing may resist the accountability that comes with formal roles. Some prefer the influence without the responsibility, and when pushed, they may disengage or depart.

Reversion under pressure. Organizations often revert to informal channels during crises or high-pressure periods. The formal approval process that works during normal operations gets bypassed when speed matters, reinforcing the informal structure.

Incomplete knowledge transfer. Some tacit knowledge genuinely cannot be systematized. The judgment developed over decades of experience may not translate into documented decision frameworks, leaving formal authorities less effective than their informal predecessors.

Cultural rejection. Teams accustomed to informal operations may resist formal processes they perceive as bureaucratic. Without genuine buy-in, formal structures become performative, followed on paper but ignored in practice.

Founder undermining. Perhaps most commonly, founders themselves unconsciously undermine formalization by continuing to consult informal channels and acting on that input. The organization takes cues from the founder’s behavior, not from documented procedures.

Based on our observations, formalization efforts encounter significant setbacks in roughly half of cases, though complete failure is less common. Planning for 18-30 months including setbacks provides more realistic expectations. If key informal leaders depart during the transition, expect 6-12 month delays while replacement capabilities develop.

Reducing Problematic Dependencies

Not all informal power concentrations deserve formalization. Some represent genuine organizational complexity that should be reduced rather than legitimized.

Identifying Candidates for Reduction

Informal hierarchies merit reduction rather than formalization when:

• The influence derives primarily from founder relationship rather than transferable competence
• The power holder resists formal accountability or documentation
• The informal structure creates bottlenecks without corresponding value
• Formalizing the authority would create inappropriate organizational structure
• The dependency couldn’t survive the power holder’s departure regardless of structure

In these cases, the goal shifts from formalizing authority to building alternative capabilities that reduce exclusive dependence on the informal relationship.

Building Parallel Capacity

Reduction requires developing alternative decision pathways before removing existing ones. Identify what capability the informal power structure provides. Train formal authority holders to deliver that capability. Create systems and documentation that capture knowledge currently residing primarily in informal relationships.

For deeply embedded informal hierarchies, this process may take 18-24 months depending on organizational size and complexity—sometimes longer for organizations with multiple overlapping informal structures. Starting early in exit preparation provides adequate runway for building replacement capacity.

Managing the Human Dynamics

Reducing informal power concentrations requires careful change management. The power holder may resist, consciously or unconsciously. Other employees accustomed to informal channels may struggle with new processes. The founder must visibly support the transition, routing their own decisions through formal channels rather than familiar informal ones.

Communicate changes clearly, explaining why formal processes matter for the organization’s future. Recognize that informal power holders may feel their role is diminishing even if their formal position remains unchanged. Some may choose to leave—an outcome that validates the dependency but is better discovered during preparation than during transition.

If the informal power holder departs during the transition, this actually validates that the structure was relationship-dependent. If they departed after adequately documenting their decision frameworks, this may represent a successful outcome. If they departed suddenly and knowledge gaps immediately became apparent, you’ve identified a critical dependency requiring urgent attention. Having a contingency plan for rapid external hiring or consulting support is prudent.

Cost-Benefit Framework for Intervention

Before committing to extensive formalization or reduction efforts, owners should evaluate whether the investment is economically justified. Not every informal hierarchy warrants intervention, and the costs of formalization can exceed the benefits for some businesses.

The Investment Required

Formalization or dependency reduction typically involves:

• 50-100+ hours of executive and management time over 12-24 months (potentially more with setbacks)
• Potential external advisory costs (varying significantly based on business size and complexity)
• Organizational friction during the transition period
• Risk of key person departures
• Possible short-term decision-making disruption

Break-Even Analysis Framework

Consider this simplified framework for evaluating intervention economics:

Investment calculation:

• Executive time cost: 75 hours × $200/hour = $15,000
• Management time cost: 100 hours × $100/hour = $10,000
• External advisory (if used): $25,000-75,000 depending on scope
• Productivity loss during transition: Variable, often 5-10% of affected payroll
• Total investment: Typically $50,000-150,000 for mid-market businesses

Potential value protection:

• Anticipated deal value: $X million
• Estimated risk discount from informal hierarchy concerns: 3-10% (varies by buyer and severity)
• Value at risk: Deal value × risk discount percentage
• Example: $5M deal × 5% risk discount = $250,000 at risk

Decision rule: Intervention is economically justified when value at risk materially exceeds total investment cost, accounting for probability that intervention succeeds.

This framework is illustrative rather than precise. Actual risk discounts vary dramatically based on buyer type, competitive dynamics, and informal hierarchy severity. The calculation helps frame the decision but shouldn’t replace judgment about your specific circumstances.

When the Investment May Be Worthwhile

For businesses where informal hierarchy concerns could materially affect valuation, typically those with significant informal dependencies and planned exits to sophisticated institutional buyers, the investment often makes sense. The management time invested in formalization may yield returns through cleaner due diligence, fewer deal structure concessions, and more predictable post-closing transitions.

When Alternative Approaches May Be Preferable

For businesses with exit values under $3-5M, less severe informal dependencies, shorter exit timelines, or less sophisticated likely buyers, other approaches may be more practical:

• Thoroughly documenting informal relationships and decision processes
• Securing retention agreements with informal power holders
• Preparing clear explanations for buyer questions about organizational dynamics
• Structuring earnouts that account for relationship-based performance factors

These approaches accept some informal structure while reducing buyer uncertainty through transparency and contractual protections. For many businesses, maintaining the status quo with clear documentation may be optimal when intervention costs exceed likely value protection.

Comparison of Approaches

Actionable Takeaways

For sellers planning exits in the 2-7 year timeframe, consider these specific actions based on your circumstances:

Conduct the shadow org chart exercise as an early priority. Gather your management team and have each person independently diagram actual decision authority. The discrepancies between these diagrams and your formal org chart reveal where informal hierarchies may operate. This typically requires 4-6 hours of management time, though larger or more complex organizations may require more.

Complete a decision audit within 60-90 days. Trace 20-30 significant recent decisions to understand how they actually got made. Document instances where informal channels superseded formal authority. Expand to 50+ decisions if initial patterns are unclear.

Assess each informal power concentration. Determine whether each identified informal hierarchy should be formalized, reduced, or managed based on whether the underlying capability is transferable, valuable, and sustainable post-transition.

Run the break-even analysis. Before committing to formalization, estimate intervention costs versus plausible value protection. If your business value is under $3-5M or your likely buyers won’t conduct rigorous diligence, managed acceptance with documentation may be more practical than extensive remediation.

Consider your timeline and likely buyer. If your exit timeline allows 18-30 months (including contingency for setbacks) and your likely buyers are sophisticated acquirers who will conduct rigorous diligence, formalization or reduction efforts may be warranted. If your timeline is shorter, your likely buyer will retain existing management, or intervention economics don’t justify the investment, managed acceptance with clear documentation may be more practical.

Engage external perspective. Informal hierarchies can be difficult to see from inside. Advisors who observe your organization as a buyer would can identify dynamics that have become invisible through familiarity.

Test your progress periodically. If pursuing formalization, have the founder step back from operations for 2-4 weeks to see whether decisions flow through formal channels. Minor informal consultation (seeking advice occasionally) is acceptable and often desirable. Critical decisions that stall without informal approval indicate more work is needed.

Conclusion

Informal hierarchies represent a consideration in exit planning that deserves thoughtful evaluation rather than reflexive alarm. The founder’s trusted advisor who enables effective decision-making, the longtime employee who embodies institutional knowledge, the unofficial leader colleagues respect—these relationships can be organizational assets that buyers value, or they can be dependencies that create transition risk. The difference lies in whether the capabilities they provide can survive ownership change.

Sophisticated buyers look carefully at how organizations actually function, recognizing that relationships can’t simply be purchased and tacit knowledge doesn’t transfer through legal documents alone. But not all buyers evaluate informal hierarchies rigorously, and some prefer maintaining effective informal dynamics over forcing premature formalization. Understanding your likely buyer profile helps calibrate how much weight to place on these concerns.

The path forward requires honest assessment of how your organization actually operates, strategic decisions about which informal authorities need attention, and realistic evaluation of whether remediation costs are justified by likely value impact. This work can be uncomfortable, sometimes revealing that the organization you thought you built functions quite differently in practice.

For informal hierarchies that represent genuine risk and where intervention economics are favorable, address them with adequate runway before exit. For those that function well and can be managed through documentation and retention agreements, transparency with buyers may be the more practical approach. The informal dynamics you understand and address thoughtfully become manageable elements of your transaction. The ones that surface unexpectedly during due diligence become the difficult conversations that complicate negotiations and deal structure.