In estimating the value of a business, so much time is spent analyzing financial statements. However, those financial statements provide a report card on the business, and whether the management team is making the grade. Human capital is typically the single most important factor contributing to the value of most businesses. Without it, ideas are not hatched, technologies are not developed, and strategies are not implemented.

What Type of Owner Are You?

Businesses are like people, no two are the same. In fact, many businesses take on the personality traits of their owner-operators. For example, a methodical business owner is more likely to have mapped key systems and procedures, documented proprietary technology, or established quantifiable benchmarks for evaluating employee performance. This groundwork can improve a potential buyer’s comfort level regarding the ability to operate the business post-acquisition. In contrast, an owner who is the rainmaker may be focused on marketing, always working to land the next customer or to build a stronger brand presence.

Both of these personality types (and many others) are equally important to business success and have a proper place in the human capital puzzle that we call personnel. The resident (tribal) knowledge and expertise of management and staff are critical not only to the business but also to a potential buyer.

As the founder, there is often a tendency to micro-manage to stay in control. If you are not in the people management business, find someone who is! The success of your business hinges on the right management team, employee relationships and the decisions made not only by you as the entrepreneur but every member of your organization.

A positive corporate culture and inspiring leadership that fosters innovation and continuous improvement are often self-evident. And rest assured, a savvy potential buyer will quickly figure out if the opposite is true.

People Power

Eventually, even the most talented entrepreneur can’t do it all and high dependence upon the owner or key employee can drive the price multiple for your business down, while also creating a bottleneck that constrains growth. Existing systems, processes and technologies will only last so long, unless constantly nurtured and modified by…you guessed it, people, specifically your employees. The right employees under the right leadership can create the better systems (and document them for you), develop new technologies, establish customer relationships and think of new ways to grow your business.

Unless your employees are at the very peak of Maslow’s hierarchy of needs (and perhaps even then), most are focused on compensation, even those interested in doing a good job. For some reason, people simply prefer to be well paid (go figure) and work in a positive environment. High employee turnover is costly not only to your bottom line because of the time and expense of hiring and training all over again, but the resident knowledge of your business may now reside elsewhere (perhaps with your competition).

While succession planning remains one of the top five challenges facing medium to large businesses, employee retention and turnover remains the top workforce management challenge, according to a recent survey of HR professionals by SHRM. The typical cost of employee turnover is estimated at approximately 33% of an employee’s annual salary based on estimates published by the Work Institute’s 2019 Retention Report, but could exceed 200% of anual salary according to Gallup.

If you don’t have the skills to hire, train, inspire, retain and lead good employees, you are not alone. Most of us have specific talents, but very few of us have all the skills needed to do an excellent job in each business function (e.g. sales, marketing, recruiting, operations, technology or accounting). And even if you did have all the needed skills, there are only 24 hours in a day. Find out what you are good at, and hire a management team, one person at a time, to handle the rest of the necessary functions.

Key Person Dependence

A high degree of dependence upon you or a couple of key employees can send potential buyers running in the other direction. While employee non-competition agreements may make some buyers feel better, these agreements (if enforceable) are rarely a good surrogate for adequate management depth and employee loyalty. If you don’t already have non-compete agreements in place, good luck convincing employees to sign one when you are ready to sell the business. And remember, a non-compete agreement doesn’t ensure that key employees stay, and it probably won’t inspire them after the business is sold.

Therefore, consider paying a stay-bonus to key employees who remain with the business after the sale. If the sales price includes contingent consideration, such as an earn-out based on future business performance, a stay bonus may be a very small price for the seller to pay in exchange for a much bigger payoff.

Take-Aways

When working “on” your business, instead of “in” your business, reflect on your human capital. Is it properly invested and generating a good return?

Choose your employees wisely. Getting rid of bad apples can be costly

Low employee turnover reduces hiring and training costs and builds resident knowledge

Reduce key employee dependence, perhaps by cross-training employees, building middle management, documenting key processes, and increasing customer touch points

Pay employees fairly, reward quickly, and provide a positive working environment to build loyalty

When selling your business, consider stay-bonuses for key employees, particularly if part of the sales price is contingent on future business performance

These steps could significantly enhance the value of your business.

Is your management team making the grade?

#valuationprocess #valueenhancement #exitplanning

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