People

Your employees are one of the two most important assets of your business – the other being your customers. Nearly every buyer will be concerned with the quality and sufficiency of your staff, so it’s wise to spend a significant amount of time ensuring there are minimal issues related to your employees that can deter a buyer. Here are several suggestions for making sure your people add considerable value to your business.

Management Team

If your business can’t be run without you and if you plan to sell your business to a financial buyer, you must usually continue running your business after the closing. To prevent this requirement, build a strong management team that can operate your business without you, or identify a successor who can take the helm when you depart.

A capable management team improves the value of any company. Unfortunately, many middle-market businesses lack a management team that can run the business without the owner’s involvement. Without professional management, your business is unlikely to thrive without you. How long can your business survive once you’re gone? One year? One month? One week? 

Building a professional management team is a Herculean task requiring a new set of skills for most entrepreneurs. When you first started your business, you likely performed most of the key tasks yourself. Once you reach a certain point, however, you must build a team to replace you, and that primarily requires recruiting and management skills. You must learn how to find and hire good people and how to get results from those people. 

Determine what position or positions would add the most value to your company. What does your company need most? Do you need a CFO, COO, VP of Marketing, VP of Sales, VP of Human Resources, or should you bring in an external president? Spend time developing a formal management team. Not only will your business be easier to sell, your revenues and profits will likely increase as well.

As an entrepreneur, you must understand that the more indispensable you are to your business, the more difficult your business will be to sell – and the less your business is worth. Learning to become a successful captain isn’t easy. To be sure, if you just received a $20 million venture capital injection, you can afford the best talent available and motivate your team with stock options and other incentives. Such scenarios tend to attract strong, autonomous, driven talent. But if you own a small manufacturing company in Boise, Idaho, and you have no institutional investors, you must learn to make do with less.

Other than retirement, this is perhaps the number one reason entrepreneurs sell their companies – because their businesses are highly dependent on them, and they feel as if they can’t escape. They have no time to relax, can’t take vacations, and have a hard time letting go. It’s a Catch-22 – they want to sell because the business is so dependent on them – but they wouldn’t sell if the business weren’t dependent on them. What’s the solution? Either way, it’s to reduce your business’s dependency on you.

Many excellent books have been written that can help you transform your company into an established middle-market business, and I recommend the following:

• Scaling Up by Verne Harnish (Gazelles, Inc., 2014) 
• The New One Minute Manager by Ken Blanchard and Spencer Johnson (Harper Collins, 2016)
• Ready, Fire, Aim: Zero to $100 Million in No Time Flat by Michael Masterson (Michael Masterson, 2008)
• The Founder’s Dilemmas by Noam Wasserman (Princeton University Press, 2021)
• Work Rules! by Laszlo Bock (Hachette Book Group, 2015)
• Organizational Physics by Lex Sisney (Lulu.com, 2013)
• High Output Management by Andrew S. Grove (Vintage, 1995)
• Measure What Matters by John Doerr (Portfolio, 2018)

It’s important to understand the circumstances in which a strong team is necessary and under what conditions you can sell your business despite high concentrations of risk in your team. It’s also essential to prioritize the actions you can take and the degree to which buyers see value in those actions. Understanding the high-level picture will help you prioritize your actions and determine to what degree you should attempt to reduce the risk and whether expanding this effort is worth the lost opportunity cost to you. 

Your employees are one of the two most important assets of your business – the other being your customers.

Staff Concentration and Dependencies

Aside from customer concentration, concentration in key employees is perhaps the most common area of concern for buyers and is one of the most prevalent areas of risk in mid-sized businesses. The smaller the business, the more likely this will be a concern. 

How much staff concentration will buyers tolerate? The degree to which this is a concern depends on the two primary types of buyers and can be broken down as follows:

1. Financial Buyers: Most financial buyers only acquire businesses that have a management team in place that can continue to run the business post-closing. If your business is heavily dependent on you, and you aren’t willing to remain with the business after the sale, it’s unlikely you’ll be able to sell your business to a financial buyer. The primary exception will be financial buyers who are planning to hire a CEO to replace you or financial buyers who own a portfolio company in your industry and plan to integrate your company with their platform company. In these cases, they won’t be as dependent on your key employees.
2. Strategic Buyers and Direct Competitors: Selling to a strategic buyer or competitor is the simplest method for reducing the risk associated with staff concentration. But the degree to which this risk is mitigated depends on the extent to which the buyer will integrate your business and products with their own. If the buyer plans to operate your business as a stand-alone entity post-closing, a management team will need to be in place to run it for the buyer after the closing. On the other hand, a concentration in responsibilities is unlikely to be considered an issue if the buyer plans to fold your product or services into their existing product suite, close your facility, or eliminate duplicate functions such as accounting, HR, and legal.

Methods for Reducing Staff Concentration Risk

Reducing your staff concentration risk can be further broken down into the following strategies:

• Distribute Responsibilities: Evenly distribute responsibilities among your team, so your business isn’t dependent on any one individual – avoid high concentrations of duties in any one employee, including yourself.
• Distribute Authority: Evenly distribute decision-making authority within your firm. Make sure authority isn’t highly concentrated in any one person.
• Build an Independent Team: Build a management team capable of developing and executing their own strategy and goals with the authority to make their own decisions. 
• Implement a Retention Plan: Develop and implement a retention plan to retain your key employees after the closing. The retention plan can consist of a cash bonus or equity incentives, such as phantom equity. 
• Sign Agreements With Key People: Ensure you have signed employment contracts with your key people that include non-disclosure, non-compete, and non-solicitation clauses.
• Eliminate Personal Relationships: Reduce or eliminate personal relationships you have with customers and delegate relationship-building evenly across your staff. Handle this transition process with care so customer relationships with your company remain strong, while still removing yourself from the equation. 
• Build Trust Through Timely Disclosure: Reassure your team that the transition provides an opportunity for them due to a potential increase in benefits or salary. Reinforce the role and value of the retention bonus. 

New Employees

Avoid hiring new employees for roles that have a steep learning curve or for roles that don’t offer an immediate return, such as sales positions. Such hires can reduce your EBITDA, which will decrease the value of your business. If you’re going to fill a new position that has a steep learning curve or a C-level position you haven’t hired for before, be sure to do so well in advance of the sale to avoid a drain on cash flow in the years running up to a sale.

Employee Compensation

Ensure all employee compensation and benefits are at current market levels. This also goes for any family members working in the business. Employee compensation above or below current market levels can turn off potential buyers and will need to be normalized to market levels, which has the potential to reduce the value of your business. While a buyer can make this adjustment to your financial statements, the fact that compensation is not at current market levels will likely bring up other questions that likewise raise the buyer’s antennae.

Employee Manual

Prepare an employee manual or handbook. Employees are a vital asset of any business. An employee manual or handbook projects a positive image to buyers that your business is well-run. Such documents set clear expectations and boundaries with employees, improve the ability to manage operations, and facilitate a smooth transition. This reduces perceived risk for the buyer and enhances the attractiveness of your business in a buyer’s eyes.

Family

Replace or reduce the involvement of any family members who work in your business. If you believe family members won’t stay on after the sale, replace them before you put your company on the market. The fewer family members working in your business, the better. Buyers get nervous about buying a business in which a lot of family members are working because they must often be replaced, or they may team up to form a coup if they disagree with any decisions being made in the business. Either way, the presence of family members in a business is risky to any savvy buyer. 

If it’s impractical to phase them out of the business, you should formalize their roles and compensation and pay them a market-rate wage and benefits. This simplifies the process of replacing any family members for your business because the buyer will know how many hours they’ve worked and an approximate replacement salary. Again, the fewer the unknowns for the buyer, the better.

Regardless, you must realize that the more family members working in your business, the more risk a buyer will perceive. For example, if you have four to five family members working in your business, some buyers will discount the value of your company by up to 20% to 40%. At a $20 million valuation, this means you’ll put $4 to $8 million less in your pocket at the closing table. Unless you love your in-laws more than 100 pounds in hundred-dollar bills (assuming a $5 million discount – one million dollars weighs 22 pounds), I recommend you begin phasing them out. On the other hand, if you do love your family, then rewarding them with a golden parachute, or perhaps 20 pounds in hundred dollar bills each, may be the wisest and most thoughtful course of action. If you really want to have fun, try giving your entire family a $1 million bonus in single dollar bills, but rent a U-Haul first because the load will weigh in at a whopping 2,204 pounds.

Employment Agreements

Make sure your employment agreements address ownership of intellectual property, and the notice period required when resigning. It would also be wise to inform your corporate attorney about your plans and ask them to review your employment agreements to make sure there are no unresolved issues that need to be addressed. While your employment agreements terminate at the closing if your transaction is structured as an asset sale, there are still potential ramifications of a poorly worded employment agreement, so it’s best to consult with your attorney to make sure no such issues exist. 

Action Steps

• Management Team: Focus on building a strong management team with evenly distributed responsibilities.
• Staff Concentration: Implement the following strategies to reduce staff concentration:
  • Evenly distribute responsibilities and decision-making authority among your team, so your business isn’t dependent on you or any one individual.
  • Build a management team capable of developing and executing their own strategies and goals, with the authority to make their own decisions. Only hire experienced people with a demonstrated history of achieving results.
  • Develop and implement a retention plan to retain your key employees after the closing. 
  • Ensure you have signed employment and other major contracts with your key people to address issues of confidentiality, non-compete, and non-solicitation.
  • Reduce or eliminate any personal relationships you have with customers and delegate relationship-building evenly across your staff.
• New Hires: Avoid hiring new employees for roles with a steep learning curve or for roles that don’t offer an immediate return, such as sales positions.
• Employee Compensation: Ensure all employee compensation is at current market levels. 
• Employee Manual: Prepare an employee manual or handbook.
• Family: Replace or reduce the involvement of family members who won’t be staying with the business after the closing. Formalize the role of all family members and pay them a market-rate salary. 
• Tenure: Address any problems with employee turnover well before you begin the sales process.
• Agreements: Make sure your employment agreements address ownership of intellectual property and the notice period required when resigning.