What The Wrong Staff May Cost Your Business
In my decades of experience with acquisitions, no topic is more sensitive that staff reduction. Unfortunately, in most acquisitions there are some employees that do not get retained. Redundant role, unneeded role in go forward business, poor performance, overpaid, etc. While owners cannot get rid of key staff prior to an acquisition, many owners seem to struggle with firing staff that are doing a poor job today. These employees are dragging down the business, but the seller would rather let the next business owner let them go. Eliminating staff that are unnecessary or underperforming can create tremendous value.
I get it. I have fired many employees over my career. Eliminating staff is never fun. No one wants to do it. Plus, you may have developed a great relationship with the employee. You care about them and don’t want to be the bad guy.
But, here is the problem: this one employee could be costing you a tremendous amount of money.
The Overpaid, Underperforming Employee
I was meeting with a client last month who knows that one of his employees is underworked and overpaid. The business needs to make some major changes, but the owner knows that this employee will refuse to do anything differently. This employee is content doing as little as possible. How is this good for the business?
The employee is costing him money today when a less expensive employee could do the same job. The same employee has no motivation to step up and help the business. So, he is not doing anything that would help the business grow. Instead, the employee is actually hurting revenue because another employee would be willing to take on responsibilities to improve the business – at a lower price. Even if a new employee was paid the same as the underperformer, the business would do better.
The Unnecessary Employee
In my career, one employee sticks out in my mind above all others. Let’s call him Ricky. I was negotiating the purchase of a medical practice. When meeting with the owners to understand which roles would not be needed after the acquisition, Ricky was at the top of our list. Honestly, we could not figure out what Ricky did all day. To our surprise, the owners said they could not run the practice without him.
“If a lightbulb goes out, Ricky replaces it immediately.” “He cleans the fish tank without being asked.” “If something breaks, Ricky knows who to call.”
Ricky was a full-time employee who seemed to have no actual responsibility. As the buyers, we joked (internally) that “Ricky probably has a full-time job online while sitting in this practice”. Of course, Ricky did not join the new company, but the value he cost the owner was substantial.
Both the underperformer and the unnecessary employee resulted in lost profits to the owner. The underperformer probably cost $10K per year in expense, but they also limited revenue growth which could have been as much as $50K more per year. The unnecessary employee was $60K of wasted annual expense. By not eliminating staff like each of these employees, you would be throwing away $120K each year – in pure profit!
Deal Value Lost
When an owner decides to sell, offers are typically made on purchase price with EBITDA, or operating cash flow). Both the underperformer and the unnecessary employee reduce EBITDA. If a buyer is looking to pay 5 times (5x) EBITDA to buy the business, each of these employees is costing the owner an additional $250K ($50K of annual expense at a 5x multiple). Two of these employees will cost the owner $500K.
No one wants to be the bad guy, but if you are planning to sell your business would you really want to leave half a million dollars on the table? If you are already planning to sell your business, it’s still not too late to recover this money.
How to Get Your Money Back
When buyers look at business financials, add-backs are taken into consideration. Common items added back to the financial performance are personal expenses of the seller that will not continue after a sale and eliminated expenses that will not recur.
As the seller, you need to be proactive. If you don’t identify and take action on certain expenses in advance, the buyer will not give you credit in the deal. However, if you were to eliminate the unnecessary employee six months prior to closing, you can definitely argue that any of the past expense for the employee should be added back to the profit.
As a buyer, I was thrilled whenever a seller hadn’t taken the right steps to reduce these costs. We would get the benefit after the acquisition, but we didn’t pay for the value. Either way, the employee unfortunately would lose their job. However, when the seller is proactive they can capture the value.
If you could eliminate one underperformer and one unnecessary employee a year before a deal, wouldn’t you want to make an additional $100K+ in current profits and another $500K in deal value? Seems like an easy answer. This is business, but it can feel personal. However, eliminating staff before an acquisition is a key way to create value.
If you would like to learn more about how Inflection 360 can help your business, please call (747) 334-2725 or click here to schedule a call.
P.S. Click here if you would like to read my previous article, Discover 10 Strategies Now To Sell Your Business For Maximum Value.