Against a backdrop of strong M&A activity in the LBM space, we have recently seen increasing focus by the government on various workforce regulations, such as treating employees as contractors or classifying workers as ineligible for overtime. It is important for companies to bear in mind the intersection of these two trends—the importance of human capital in M&A transactions.
Nearly all memoranda describing a company to potential buyers include a section containing the managers’ biographies. Potential buyers want to see that the management team is well seasoned and has a track record of success. Buyers favor companies where the management team is far enough along in their career to have gained wisdom and good judgment. At the same time, buyers want to know that the managers who will run the company after the owner departs are not near their desired retirement age.
For owners who will eventually seek to sell their company, it is important to establish the right general wage and salary policies. It is possible that a charismatic business owner can create a warm and engaging environment for workers, making them willing to accept somewhat below market wages. If that environment changes after the acquisition of a company, though, workers may experience increased awareness that other companies are paying more.
If, on the other hand, a company pays its workers too generously, a buyer may not be willing to inherit that inflated wage structure. No one wants to implement a general wage and salary decrease after acquiring a company. The buyer will be forced to build the current salaries into their model, lowering the selling owner’s valuation.
In the scenario where a buyer believes pay is lower than market, they will need to reduce the EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) they perceive themselves to be buying by factoring pay increases into their model. Notions of pay equity become particularly important for strategic buyers. When a strategic buyer folds an acquired company into their existing business, it does not take long for workers at various levels of the organization to become aware of and react to pay discrepancies between the legacy and newly acquired firm.
Another critical human capital aspect of acquisitions concerns gaps in the selling company’s management bench. If your general manager has been pinch hitting for the departed operations manager or the chief financial officer is in dire need of the help of a controller, buyers will detect these shortcomings. It does a company no good to try to gloss over these holes in the management team. A smart buyer will detect them and factor into their financial model the hiring of whichever individuals are missing.
If your head of finance is overwhelmed with their current duties, what will happen when they have a large parent company, a private equity fund, or a senior or mezzanine debt provider for whom they must prepare reports? For some of these constituents, monthly reporting isn’t frequent enough. That’s right—weekly financial recaps are often required.
Once dialed in, most companies report that conforming to such reporting requirements actually improved the overall operations of the company and the reports became very routine. It’s not possible to get to that stage, though, without competent finance and accounting staff. Highlighting a gap in your team that the buyer needs to fill means that they will take a deduction to your EBITDA, resulting in a lower valuation. That’s not what sellers want, but it is a small price to pay to keep a smart buyer interested in your company.
In an ideal situation, a selling owner will identify and seek to fill or replace any open positions or weak links in the management chain. In that way, the execution risk for the buyer is lower because they do not have to recruit for the positions after closing.
This is especially true of the critical president position. If at all possible, buyers should select and groom an internal candidate to take over the company after a sale. When the founder becomes the CEO and the second-in-charge becomes the president, the company is well positioned for a sale. A buyer can let the president run the company post-sale or install their own candidate at the CEO position to oversee the president. Handled correctly, human capital decisions like these can enhance the value of a company in the eyes of prospective buyers.