The Business Owners’ Special Series (B.O.S.S.) No. 28
By Rich Gunn, Partner, Advisory
“Of course, my business has a high value. My employees are terrific. A buyer would pay a premium to acquire a business with my management team.”
While that may be an honest assessment of employee value in the eyes of the business owner, that value may look far different in the eyes of a potential buyer. Buyers search like bloodhounds for the weaknesses and risks within potential companies and will reduce their offer price as a result of impairments they find in your employees, your management team, and your human capital. Take the example of Jayne and her public relations firm, which she is looking to sell in the near future.
“Jayne” owns a public relations firm that has 20 employees and has a developed a strong niche of clients within the healthcare industry. Contemplating retirement in five years, Jane and I discussed her employees in the context of exit planning and overall business value. Jayne was keenly aware of her management team’s strengths. However, she was quite surprised to discover the weaknesses and risks that a buyer would find in her overall human capital — negatives which ultimately reduce the value of her business. After asking several questions about her employees, here is what we found about Jayne’s human capital value.
There is a strong sense of loyalty in Jayne’s management team, as each member has been with Jayne for at least eight years. In addition, the team exhibits a high level of customer service skills, as Jayne explains that she can go on vacation at any time and the clients will be in great hands while she is away. This indicates that the business does not rest entirely on Jayne’s shoulders, which is a good sign for potential buyers. A business that is overly dependent on the owner is a business with little value.
Seeing Through the Buyer’s Eyes
Given that Jayne has a management team with extensive experience, strong loyalty, and excellent client service, how could a buyer find weakness in Jayne’s human capital? Although there were many strengths amongst the management team, many risks and weaknesses revealed themselves upon analysis of Jayne’s human capital value.
- The Rainmaker Issue
While Jayne’s team was perfectly capable of taking care of the existing clients, Jayne was still the primary source of new business. Jayne never developed or hired any rainmakers in her management team. In other words, without Jayne, there is no revenue growth.
- Staff Loyalty… to Whom?
Jayne’s managers have been with her for at least eight years. Each member has declined opportunities to work for larger companies offering higher salaries because they enjoy working in Jayne’s business, affirming Jayne’s statement of their loyalty. However, Jayne never questioned exactly where their loyalty lies. Does their loyalty lie with Jayne or with Jayne’s business? When Jayne exits the business, will the loyalty of Jayne’s team leave with her?
This is an important question because no matter how good your management team is, a buyer will place a huge discount on the value of your human capital if they do not have the confidence that your management team will stay with the business once they acquire it.
- Where Is the Incentive?
Let us assume that a large player in the same industry is interested in acquiring Jayne’s firm and they are impressed with Jayne’s management team. However, can Jayne provide any assurance to the buyer that her management team will remain with the business after Jayne’s exit? It became apparent that Jayne has a huge knowledge gap about her team’s overall human capital value and how it could reflect on the attractiveness of her business to buyers.
- Jayne has never discussed her exit plans with her management team, so she is completely ignorant as to how they might react to her exit and whether they would remain with the company after her exit.
- Jayne also never considered that implementing stay incentives may be necessary to encourage her team to stay with the buyer after her exit.
Before Jayne can boast about the strength of her management team to a potential buyer, she must be able to say with confidence that her management team plans to work for the buyer moving forward. Failure to do so represents a huge risk and reduction in purchase price in the eyes of the buyer.
- The Age-Old Questions
Jayne is 60 years old, she is in good health, and she has very specific retirement plans. This includes selling her business in five years and relocating to the opposite coast to be closer to her grandchildren. That is terrific for Jayne, but what about the retirement plans of her management team members? A buyer is likely to be very interested in older management team members’ timelines regarding retirement. Jayne has always assumed that she would be first to retire, and failed to inquire about her managers’ retirement plans and timeline. This is another gap in Jayne’s knowledge of her human capital value.
Jayne disclosed that the most senior member of the management team was two years older than herself. Therefore, it is quite possible that this manager would retire with Jayne, or perhaps, even retire before Jayne sells her business. Obviously, the loss of a key manager shortly before sale does not bode well for the value of your human capital.
Jayne did not know the ages of her other management team members, but she guessed they were “in their late 50’s.” If Jayne were to sell her business in five years as planned, these team members will be in their 60’s at the time, and very close to traditional retirement age themselves. It is likely that if these managers can afford to retire when Jayne sells her business, they may do so.
- The managers may not be interested in continuing with a new owner or a larger company that may impose many changes in processes, procedures, and company culture.
- They may lament the loss of autonomy in their work and not like the idea of reporting to their new company’s vice president, and they may choose to retire when Jayne retires.
These risks could result in a larger decrease in value for Jayne’s human capital.
- What About the Next Generation?
When we inquired about the junior staff, the next generation of leaders and the future management team of the business, we uncovered more issues. While Jayne was successful at hiring and retaining experienced talent, she had little success in retaining and developing junior talent.
Jayne justifies the high turnover of the junior staff as a “generational thing that everyone is experiencing,” thus outside of her control. The reality is that as long as the senior staff retention was strong, Jayne never took a hard look at the root of the problem of her junior staff turnover, thus she didn’t understand the real causes of the problem, which could be any of the following:
- The company’s culture is not attractive to the next generation.
- Senior staff may not be very good at delegating, training and supervising junior staff.
- Managers may have an attitude of “time is money and it’s faster if I just do it myself.”
Jayne never looked closely at the cause, so she could never implement practical solutions to resolve turnover. If better practices were put into place years ago, Jayne would have added greater value to her human capital today and enhanced her overall business value in the eyes of a buyer.
- The Human Capital System
Further inquiry discovered that Jayne’s business lacks a comprehensive system for effectively managing her human capital. The business lacks processes for attracting, training, developing, challenging, inspiring, rewarding and retaining junior staff. Without an effective human capital system, the failure to develop the next generation of leaders is inevitable, resulting in another huge discount to the value of Jayne’s business in the eyes of a potential buyer.
Key Lessons Learned
Jayne thought that her management team would attract a premium price for her business. Now, with eyes wide open from our discussion, Jayne learned the following about the real value of her human capital:
- Having a team that satisfies the current owner’s needs does not mean that your business has strong human capital value in the eyes of a potential buyer. The first step in effective exit planning is to see your employee-value through buyer’s eyes, and not be blinded by your own perspective and biases.
- The strongest management team has little value to a buyer if the buyer has no confidence that the team will remain employed by the business after they acquire it. It is on the seller to ascertain and demonstrate that the management team will stay with the company after the sale.
- A strong management team has some value, no doubt. However, having a comprehensive system and process for developing and managing your human capital has far more value than just having a few good people.
- Jayne should have been focusing on developing her human capital systems many years ago to set a strong, lasting foundation so that her business would have greater overall value today.
As any Certified Exit Planner will tell you, we as a profession strongly advocate for early-stage exit planning so that business owners like Jayne can have highly effective human capital systems in place throughout the entire life of their business. Owners should benefit from having these business enhancements in place while running their business, and not to put them in place only when they are ready to sell. Jayne could have reaped greater rewards from her business if she implemented a highly performing human capital system and process many years ago, in addition to having a business with a higher value today.
Discover More Exit Planning and Value Acceleration Insights
This article is No. 28 in the Business Ownership Special Series (B.O.S.S.), an ongoing cycle of informational guides from BPM designed for business owners who are proactively seeking guidance from experts on how to implement value acceleration in their business, delivered each month straight to your inbox. For more insights, download our e-book, “Value-Focused Business Planning,” and check out the rest of our B.O.S.S. articles.