Due Diligence

There are two subjects that constantly arise regarding the employees of a company that is being sold.

The first of course, is that a buyer will want to meet the employees before they close the deal. Naturally, most sellers are completely against the idea.

The second issue generally arises during the valuation process when buyers factor in the cost to have a manager in place to operate the business and therefore they reduce the Owner Benefit’s figure accordingly.

One thing is certain: the discussions can get pretty emotional on these points.

While there can be valid arguments to both sides, often, it is a general misunderstanding of the business-buying process itself that causes the accompanying friction.

Meeting Employees

There is no doubt that any seller has a legitimate concern about a buyer meeting their employees.

In addition to the obvious worry about confidentiality, there is an underlying fear that “someone will say something to kill the deal”. Yet from a buyer’s perspective, how can they possibly make this investment without knowing who will be working for them?

There are four rules that a buyer should follow in this predicament:

  1. If there are no high level, key employees in the business, it may not be necessary to meet any of them at all.
  2. It is only reasonable that if any meetings with employees need to take place, these should only come after the other main deal contingencies have been satisfied. It is not fair to jeopardize the seller’s business, or panic the employees, until you know that you are prepared to move forward with the purchase outside of this one remaining point.
  3. Any introductions should be done under the guise that you and the seller are comfortable with presenting so as to protect both of your interests. And again, it is only necessary to meet with those who occupy critical positions within the company that could drastically impact the business’ future if they were to leave after a sale. On the other hand, if the business cannot survive without certain employees, you have to question whether or not you should be buying it altogether.
  4. Finally, if you determine that based upon the business model and its future with you as the owner, it is paramount that you meet certain employees – you have to stick to your position.

Reducing the Owner Benefits to Account for a Manager

The premise behind presenting Owner Benefits, or Seller’s Cash Flow, or Adjusted Earnings (they all allegedly should mean the same thing), is done based upon a single owner-operated business. In other words, the seller leaves, and the buyer takes their place.

When calculating a valuation, a buyer will sometimes reduce the Owner’s Benefits and factor in the cost to employ a manager. However; this is strictly a formula to determine your investment return versus other opportunities. It is not a proper way to assign a valuation to a small business.

You may see a business where the owner has no daily involvement and therefore a manager’s salary is added back because the assumption is made that the buyer will no longer need the manager.

Here again, the concept being that the buyer will be running the company. These assumptions on the part of the seller are correct.

Similarly, if there are two active owners in a business, and both are leaving, the buyer must add-back the cost he will incur to replace the second partner.

Remember, when calculating the value of a business, normalizing the earnings regarding personnel is done based solely upon the single owner-operator concept.

I have rarely seen buyers and sellers agree from the onset on what the add-backs should be. And it is common for the add-backs to sometimes be a bit of a stretch. The key for both sides is to have a logical argument if they wish to debate an issue. It is not enough to say “my accountant says so” or “this is how it is done”. Undeniable proof, backed up with demonstrative rationale, is what prevails in these discussions.

The whole subject of add-backs can get quite heated and I will table more of these in upcoming issues.

In the interim, here are two excellent questions/answers to read about what constitutes legitimate add-backs and another situation a buyer wrote me about meeting employees before you buy a business.


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