People are Assets too!

This is number 4 in our series on Compensation in Private Companies and examines the role of incentives in business succession. Parts One, Two and Three can be viewed here.

Most employers say that “Our employees are our most important asset” and this becomes very quickly evident in a business succession transaction today.

A buyer’s due diligence will always look for risks not disclosed in financial statements, that might jeopardize the successful integration or the business’ operation after purchase. The most likely area to contain such risk is human capital, which is the cause of why many business combinations fail to deliver the value that they promised. At a time when the supply of skills is diminishing and a generational shift is occurring in the workplace, this has never been more important.

Owners contemplating succession must have their business “sale ready” or may not realize their price expectations. Potential value killers should be addressed and rectified before a transaction appears. Qualified buyers are hard to find and transactions take time to complete.

The success or failure of a transaction will reflect the level of workforce engagement toward the transaction, the acquirer and the buyer’s leadership and that will be a function of how well a seller has prepared.

A sophisticated buyer will examine the level of engagement and work environment and only if satisfied that the business can continue to be operated with minimum distraction will offer a purchase price at the top of the range.

A business ready to be sold must, therefore, be ready to discuss:

• The Talent Inventory – the individuals, not necessarily executives, who are key to the success of the business e.g. engineers, technicians, product knowledge experts, or those who influence the opinion of others in the organization. A seller must be able to identify these to a buyer and where possible have a plan for their succession when needed.
• Leadership – a buyer will want to know and observe the extent to which the founder is involved in day-to-day activities. If it can be shown that the owner has exited day to day management this will likely enhance the sales price. If a business cannot operate without the owner (who will disappear after the sale) a buyer will have concerns. Successors for other family members working in the business should also be identified if they are not making the transition to a new owner.
• Culture – understanding the values of the organization, the way employees interact and the leadership style will be important for a buyer to be able to plan integration with their existing business. A seller should document the leadership model and the principle components and ensure it is institutionalized. The culture of a successful business does not happen by accident.

For the best results, a seller should address these areas as an evident and longstanding element of their management model. Whether they exist and how they manifest will be of keen interest to a buyer. A seller should conduct pre-sale due diligence to identify and document these processes before going to market.

Completing a business succession transaction is a significant undertaking and will involve a number of the seller’s management and as the buyer’s due diligence widens is likely to increase.

Motivation will be critical during what will be a stressful period when individuals will be worried about their jobs and futures. With no information, they will make negative assumptions about their positions in the new organization. For the sake of continuity departures from the seller’s transaction team must be avoided and an owner should be prepared to incentivize completion of the sale and the team’s retention.

The transaction team will likely start with the CFO, who will carry the major share of the workload. An Employment Agreement Addendum will set out severance triggers and a financial incentive to remain with the company through the transaction and beyond.

A completion incentive may take a number of forms but usually represent a small percentage of the sale proceeds and of course, no cost if the transaction does not proceed. The cost is insignificant compared to the enterprise sale value but will mitigate the risk of transaction failure and may even help to obtain a higher sales price.

Motivated employees will be attractive to a purchaser who may be willing to share the cost of a retention incentive thus avoiding recruitment expenses. The objective of an incentive is to alleviate employee concerns about their security during an uncertain time as well as to motivate additional personal effort to close the transaction.

No one can envisage a transaction’s upside potential better than a buyer. Our role is to use the experience gained from many similar transactions, to help sellers achieve their targeted sales price for their business and buyer to avoid the pitfalls that jeopardize their vision.