SELLING A BUSINESS

Jul 11, 2022

Why Employee Tenure Matters

Oftentimes, buyers of small businesses will focus a decent amount of their diligence efforts on the employees. They will ask for historic payroll records. They will ask for key employees’ roles and responsibilities. They will ask about their strengths and weaknesses. 

Behind the scenes, they are trying to understand how much risk there is in employees leaving or asking for a raise as soon as the business is sold. They want to know how hard it will be to replace or add to a given position. Has the owner historically over- or underpaid employees? Is the labor market very tight? Does the owner have unique strategies for recruiting and retaining talent? 

Concerns may arise when the existing employees have only been at the firm for a short amount of time (i.e., less than two or three years). When owners hear this concern, they often do not understand where it is coming from. 

Longer tenure means lower transition risk

At the end of the day, buyers want to understand what’s the risk and what’s the reward behind buying a business. As most buyers will be using a personally guaranteed bank loan to acquire a business, they are worried about the business going downhill after the sale, making it hard or impossible to make loan payments.

One form of risk is around the transition. Will the buyer be able to keep the business operating as well as the previous owner? Will the employees stay on under the new owner? Will the employees immediately ask for raises and drive up the payroll costs?

Businesses that have longer employee tenure have lower transition risk, all else being equal. Each year that an employee works at a firm, he or she captures more and more “institutional knowledge.” This is knowledge of how things work, what pitfalls to be aware of, etc. Given that small businesses typically have little to no documentation of procedures and processes, institutional knowledge accounts for most of “how things work around here.”

This means that after the ownership transition, long-tenured employees can help the buyer as he or she operates and grows the business. Time has taught these employees valuable lessons that they can pass on to their new employer.

It’s cheaper to retain talent than to hire talent

If the average employee tenure is only a few years but the business has been in existence for decades or more, typically that means the business has a relatively high employee turnover rate.

High employee turnover rates mean that the buyer will have to invest a fair bit of time into hiring each year just to keep the business stable. 

It’s widely known that it costs more to hire new talent than to retain existing talent. According to Employee Benefit News (EBN), turnover can cost employers up to 33% of employee salary. Aside from hard costs of the time spent finding a replacement and the lost revenue while the employee ramps up to full output, there are additional indirect costs such as an impact on morale and lost institutional knowledge. 

The past few years have seen incredibly tight labor markets

The issue of employee retention and tenure is especially heightened today. The past few years have been some of the toughest in terms of hiring great talent as the demand for labor has vastly outpaced the supply of labor. More firms are hiring than ever before, and they are struggling to quickly find candidates to fill their roles.

AutomotiveResearch.com found that finding good, knowledgeable, and motivated technicians was the second most common challenge for independent repair shops. The auto repair industry is not the only sector facing tight labor markets. The James Beard Foundation found that staffing was the number one challenge facing restaurant owners (78%). 

What does this mean for your business sale?

First, work hard to retain as much of your current talent as possible. The Work Institute releases a Retention Report each year, which cites career development, work-life balance, and compensation as the top reasons for employee turnover. Owners should work to make sure their employees feel like they are developing as a professional and should make sure that the compensation is appropriate for the market.

Second, assure any prospective buyer that you will help him or her hire throughout the transition period. It’s no secret that you are better equipped than they are to source new candidates and vet them to ensure the potential hires have both the hard skills and right attitude to fit into the business you’ve built. 

Third, acknowledge that if you do have abnormally short employee tenure, then you may need to be a bit more flexible on either the deal size or structure. You may have to discount your asking price slightly compared to the average multiple. You may have to offer more seller financing, as a form of showing skin-in-the-game to help them hire.

Parting Words

Good employees are worth their weight in gold in this market and savvy buyers know it. You can bet that prospective buyers will want to have a strong sense of confidence that they’ll be able to retain and grow the human capital associated with the business. Anything you can do to build confidence in your HR department (or assist with the hiring process) will pay dividends when you take your business to market.

Will Simmons

Transaction Advisor

Information posted on this page is not intended to be, and should not be construed as tax, legal, investment or accounting advice. You should consult your own tax, legal, investment and accounting advisors before engaging in any transaction.