M&A Deal Killer Miniseries #3: Human Capital Concentration

M&A Deal Killer Miniseries #3: Human Capital Concentration

Diversifying your team is a critical step in preparing a business for sale.

When selling a business, it’s obvious which factors matter most. Financials, forecasts, and client concentrations are all critical components to facilitating a successful M&A transaction and showing buyers a business is a low-risk investment. In addition to these obvious factors, there are some lesser-known items that are just as important and if not carefully curated prior to the deal closing, could sabotage a transaction or scare off the perfect buyer. One of the most important parts of a good business is a strong, diversified team. As part of our 10-part mini-series on M&A deal killers, this article will explore human capital concentrations in small business and how to identify, resolve, and prevent this problem in your own business.

What is a human capital concentration issue? Human capital concentration is when key employees control business revenue, vendors, sales or operations from lack of cross training. This situation can be risky to business owners because these employees are usually the only ones with sufficient knowledge to complete certain tasks, this creating a rift in operations in their absence. When selling your business, buyers want the security of knowing that no matter what happens with an employee, there are multiple people on the team that can do any particular job. After all of the years of hard work that you have invested into your business, you deserve a seamless and profitable sale, and it would be devastating to lose that opportunity due to an undiversified team. If you think you might have a human capital concentration issue in your business and need help addressing it, we have outlined the strategy below to help you.

What are the risks of a human capital concentration problem?

The first step to resolving an issue with your staff is understanding how harmful it could be to your business. Not only could high human capital concentrations kill a fantastic M&A deal, but they can really hurt your day-to-day operations. Issues among your staff are likely to grow if action is not taken and over time, you will see the issues leak into other areas of the business and impact the financials. Here are some of the ways that human capital concentrations can harm your business if not addressed.

• Buyers seek businesses that demonstrate minimal risk. An undiversified team can present risk for an owner who is new to the industry and doesn’t have relationships with the employees yet.

• If your team isn’t cross-trained, the absence of the one skilled employee in each sector becomes a threat. If an employee was to quit or take a leave of absence, who would pick up the slack if no other employee understands that job? It may fall on the owner or be poorly completed by another employee, ultimately leading to impacted client relationships or diminished revenues.

• Transitioning a new owner into a business with an undiversified workforce will affect the business. The new owner will not be skilled enough to replace the previous owner as the “go-to” person, and the business may suffer if another employee is not able to seamlessly take over for the absent employee. This poses the risk of decreased productivity, overwhelming the new owner, hurting customer relations and impacting profits.

• The risk of an undiversified team may put the seller at a disadvantage during the sales process, leading to an earnout or seller financing.

• Once the previous owner finishes up the training period, the new owner won’t have anyone to learn from in the absence of a skilled employee. Because of this, tasks or projects that shouldn’t take long may be dragged out and ultimately lead to poor service quality and decreased productivity. Morale among the team may also suffer due to increased strain through the team.

How can I identify a human capital concentration issue within my company?

Identifying a human capital concentration issue in your organization is pretty simple because it usually manifests itself in two main ways. One, your staff is not diversified in terms of skills and training, meaning only one person knows how to do one job. The other scenario is when one employee knows way too much and is hoarding all the knowledge and power of their position. Both scenarios create risk for the company. These are the two main ways to identify a problem in your organization.

• If a team member is out of the office, the department suffers or work remains incomplete. No other employee has the knowledge needed to fill the role during the absence and the organization as a whole, falls behind.

• One person has an uneven amount of knowledge pertaining to their role or a specific client and no other employee has the opportunity to get involved. When one employee hoards all the information in regards to a client or project, it’s time to take action.

My business has an issue with human capital concentration – how can I work to resolve it?

If you have discovered an imbalance in your human capital or revenue distribution among your employees, there is a solution: implementing a cross-training program. Cross training employees tends to make employees more knowledgeable as well as assisting in the team building aspect that is desired by Purchasers. This solution is relatively simple and will benefit your business in a variety of ways including building value among your team, reducing risk, and increasing the appeal of your business to buyers. Here are three different instances in which you can introduce cross-training into your employee’s daily routine.

• Training Manuals: The first step to implementing a good cross-training program is to document all of the training material in a manual. We recommend creating manuals based on positions so that if an employee is ever gone, there are notes so that other employees can resume where they left over. Good documentation of processes and procedures will ensure that no employee is too powerful or the only person that can complete a certain task.

• Peer Training: Pair your employees up and allow them to teach one another the fundamentals of their jobs. Typically, its best to start this among employees in the same department so that the department will never suffer. Depending on the size of your business, you should eventually move to training employees on other areas of the business to ensure coverage at all times.

• Group Projects: To prevent any one employee of housing all knowledge related to a certain task or client, turn these situations into group projects when it makes sense. For example, assign two sales people to every major client or have other employees peer-review projects so that more than one team member will have knowledge and experience in that area.

How can I prevent future issues with human capital concentrations?

If you have reached this level, congratulations on taking steps to address an employee issue within your organization. After spending the time to resolve the issues, it’s critical that you ensure the same issue does not manifest itself again. To ensure your business never faces a human capital concentration again, follow these steps to implement preventative measures.

• First Day Training: The first day of the job, which is often the beginning of the training process, is an important time for you as an employer to introduce cross-training. This process should include job shadowing of many different individuals performing different occupations or tasks within the company to give the new employee insight to the different positions

• Team Building: Make diligent notes of the different requirements/knowledge of each position or department within the business so that you can have training sessions to further educate your employees. Include all employees, regardless of tenure or experience level, so that they too can learn from the employees that have helped the company develop over the years thus assisting the businesses productivity.

• Large Projects: Special projects are a fantastic opportunity for employees to learn new skills at work. A great way to take advantage of this scenario is to start by conducting an assessment to see what skills are needed for the project and which skills you have on hand. Then, pair up your employees based on contrasted strengths and weaknesses so they can learn from each her. Not only will the employees pick up new skills from their cohorts, this is a good chance for employees to bond with coworkers they may not normally interact with. Regroup with all the pairs and give employees the opportunity to ask questions, express concerns, and how they handled different situations so that again, everyone can learn from each other.

If you have realized that you have an issue with your human capital concentration, do not worry – this is one of the easiest M&A deal killers to rectify and prove that you have resolved. Over the years, we have worked with hundreds of business owners who faced human capital concentrations issues and our game plan has helped many of them fix the problem and increase the value of their company. Because these business owners addressed the issue early on, they were able to get more money for their business and an easier transitional period. As you prepare for the next stage of the small business life cycle, it’s crucial that you recognize the issues that threaten M&A deals so that when you are ready to sell, you can secure the best price possible for your business.