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 foundations of a good business is a strong, diversified team. This installment of our 5-part series on M&A business deal breakers explores Deal Killer #3: human capital concentrations in small businesses – and how to identify, resolve, and prevent this problem in your own business.
Deal Killer #3: Human Capital Concentration
Diversifying your team is a critical step in preparing a business for sale. So, what is a human capital concentration issue? Human capital concentration is when key employees control business revenue, vendors, sales, or operations and lack cross-training. This is risky to business owners because, since these employees are the only ones with sufficient knowledge to complete certain tasks, there is a rift in operations in their absence.
When selling your business, buyers want the security of knowing that no matter what happens with a single 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, review the following considerations.
1. 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 it can 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 a 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 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 understood 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 should be conventional 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 on the team.
2. How to Identify a Human Capital Concentration Issue
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 one person only knows how to do one specific 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 backfill 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 pertaining to a client or project, it’s time to take action. No one person should have the power to make or break your business.
3. How to Resolve a Human Capital Concentration Issue
If you have discovered an imbalance in your human capital or revenue distribution among your employees, there is a solution: implement a cross-training program. Cross-training provides employees with valuable knowledge while also fostering a team-building culture that Purchasers find desirable. 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 ways you can introduce cross-training into your employees’ daily routines.
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; that way, if an employee is ever gone, there are notes other employees can use to resume where they left off. Good documentation of processes and procedures will ensure that no employee is too powerful or the only person that can complete a certain task.
Pair up your employees and allow them to teach one another the fundamentals of their jobs. Typically, it’s 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 train employees in other areas of the business to ensure coverage at all times.
To prevent any one employee from housing all knowledge related to a certain task or client, turn these situations into group projects when it makes sense. For example, assign two salespeople 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.
4. How to Prevent Future Issues with Human Capital Concentrations
After spending the time to resolve existing 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, work to implement the following preventative measures.
First Day Training
The first day on 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 many different individuals with different occupations, performing different tasks within the company to give the new employee insight into several positions and departments.
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 they too can learn from the employees that have helped the company develop over the years.
Special projects are a fantastic opportunity for employees to learn new skills. 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 contrasting strengths and weaknesses so they can learn from each other. Not only will employees pick up new skills from their cohorts, but this is also a good chance for employees to bond and develop relationships with coworkers they may not normally interact with. Later, regroup with all the pairs and give employees the opportunity to ask questions, express concerns, and share how they handled different situations so everyone can learn from each other.
If you’ve realized 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 to prove that you have resolved. Over the years, we have worked with hundreds of business owners who have faced human capital concentration issues. By partnering with Viking and establishing a game plan, we 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 increase the value of their business, receive more cash at closing, and experience an easier transitional period.