Acquiring new leadership can ding your valuation

John Wagner - working capital peg

Acquiring new leadership

Many executive leaders of private companies are often owners or significant shareholders, and an acquisition is a natural time for them to cash out, or even to take their feet off the gas under new ownership once a deal is closed (and their financial security is assured). Without proper planning, those leaders who are departing, or who wish to remain but whose waning enthusiasm may be detected by an acquirer, can be quite pricey for you as a seller, and this situation should be yet another reason to avoid acquiring new leadership in advance of a sale.

Here’s why: If you are the seller, and you wait too long in acquiring new leadership who will leave just after the deal closes, you might very well get docked for the replacement cost (salaries and benefits) of departing key team members, and potentially even the costs of replacement talent acquisition through a head hunter.

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Given that these costs can have a negative valuation multiplier effect, the financial punishment can be quite severe. Zapping $200,000 off your EBITDA to replace a departing CFO’s compensation package too close to a sale can lower a company’s valuation by $1.2 million if the company is being valued at 6X EBITDA.

In the absence of leadership continuity or well-planned succession planning, acquirers will consider devaluing (sometimes severely devaluing) a leaderless or thinly-led company. It should come as no surprise that acquirers want as little churn or disruption as possible when a deal closes. Their aim is an operational steady-state that doesn’t suffer in ownership transition. So, this devaluation can potentially knock multiple turns off the valuation calculation, driving down the multiple from 6X EBITDA to 5X or 4X. In fact, if the acquirer realizes they are going to end up with the husk of a company, they might even consider entirely walking away.

The product lineup, the customer base, and that nifty website…sure, those things are necessary, but they can be decidedly secondary in a valuation equation to solid leadership. Acquirers surely want those branded assets, and a great employee culture besides, but that’s just a baseline; moreover, you’re naïve to think these company features can be delivered by just anyone.

In every deal we’re involved in, prudent sellers and shrewd acquirers make it a priority to ensure that the leadership (and often the middle management) which made the company attractive enough to acquire are retained after the deal closes to provide leadership to take the company forward.

That means far more than just avoiding acquiring new leadership and keeping a few name plates on C-suite doors. It demands that able leaders remain in place to retain the workplace culture, customer relationships, vendor relationships (and a myriad list of other intangibles) to ensure the continued success of an operation.

Some acquirers even want to see the trailing financials during which the future leaders of the company had significant authority. Naturally, if an acquirer likes those financials, they’ll want to keep the leadership that put up those numbers. If not, all bets may be off.

Keep in mind that putting a solid team in place can be a long process. As a seller, if you’ve made the wrong hire, you need enough time to determine if a particular hire was ill-advised. (Harvard Business Review reports that Fortune 500 leaders run about 50% success rate on hiring decisions!)

Communicate  the  acquisition:   When an  acquisition is about to take place or is taking place, news of the deal should not come as a surprise to the seller company’s lead- ership, although it may be prudent to keep the news from rank-and-file employees until a well-planned, sequential announcement strategy is put in place. Follow this timeline: Ownership —> Leadership —> Employees —> Customers Vendors —> the Public/Press. If this is not done properly, you can only imagine the damage control you’d have to do if you suddenly broke the news to the management team that the company has been sold. Some might even walk off resentful they weren’t kept in the loop; others will wonder if they had not been told because the ink is still drying on their pink slips.

Bottom line: Acquirers look for a solid and well-articulated succession plan to be in place even before they start drafting the paperwork to make an acquisition; moreover, the absence of a plan should raise general concerns that the target company is truly prepared for an ownership transition.

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