Creating Enterprise Value Through Human Capital

By Tom Bixby, President & CEO, LEVEL Management Partners
Published October 8, 2020

This article continues our series on building value by prescribed actions in functions across an enterprise. We've covered Marketing and Sales disciplines and now we turn our focus toward Human Capital. Naturally, people are the common thread through all functions of a business, and you'll find human-related growth actions in all disciplines. In this article, we'll focus on the over-arching management actions central to creating, or preserving, enterprise value.

We recently organized a panel discussion on this topic, facilitated by Bruce AmEnde and featuring a Human Capital expert, an Investment Banker and an M&A Attorney, all drawn from the LEVEL Expert Network™. We began our discussion by asking our Human Capital panelist, Maria Forbes, President of FIREPOWER Business Catalyst, LLC to define Human Capital Management. Maria explained that Human Capital Management refers to the systems and processes supporting the people in a company as one of its largest assets.

People should be thought of as part of a critical value-building framework. Human Capital Planning is in the preparation phase for a sale, not part of the actual deal process. It happens well in advance of the sale, getting companies ready for increased value and competitive market positioning. Human capital within succession planning is a long-term investment, driving people-ROI.
-- Maria Forbes, FIREPOWER

Our Investment Banking panelist, Eric Togneri, Managing Director of Neri Capital Partners, shared that Human Capital is one of the most important and most overlooked areas for preparation that business owners take in putting their company out to market. Eric emphasized the importance of business continuity planning for a smooth business transition across the entire enterprise. The owner must proactively facilitate this discussion and create an environment presenting less risk for the investor, the buyer of the organization. The owner must define how an investor would transfer internal and external stakeholders in an orderly manner. Buyers may be willing to pay an additional 1x to 2x adjusted earnings for smooth continuity.

A key to business continuity planning, especially in lower middle-market companies, is clear documentation of how each person contributes to the success of an organization.

What tends to happen in these smaller companies is everybody wears multiple hats. There are no firm job descriptions. You need to get the employees on board early by talking about exactly what their function is within the company, not some title, not some place on the org chart. What does each individual actually do, and how does this company actually function. The new owner will get to know exactly who is doing what, and the employee gets credit for what they are actually doing. The new owner will need to know the value of each employee within the overall operation of the business.
-- Eric Togneri, Neri Capital Partners

Our M&A Attorney panelist, Gary Smith, Attorney and Founder of Venn Law Group, was asked to comment on the tools used to offer incentives for key employees to remain committed and productive through transition. Incentives should address both psychological and financial elements. It is critical to know what matters psychologically to key employees, to not only help them stay through an exit to benefit a potential buyer, but also to help grow the company to get to that exit.

From a psychological perspective, incentives can be titles, or being involved in the transition strategy group, or some other group that is particularly important to the company. For financial incentives, they should be structured to provide substantial benefit to an employee at least one to two years after closing. The employee should recognize a need to stay with the new buyer to effectively transition the business rather than leave the company as an ownership change results in culture change. The goal should be to get people excited about the transition with the psychological component and follow with the financial component, so that when people are not as excited about it they at least think twice before jumping ship.
-- Gary Smith, Venn Law Group

Gary also shared while addressing the psychological and financial needs of key employees can be an effective retention incentive, most buyers will also look for these employees to have signed non-competition agreements or other restrictive covenants ensuring they would not act in a way that would harm the business if they were to leave the company. Insightful employers make signing these agreements part of the normal hiring and onboarding process, as it is much more difficult to put those agreements in place later. In general, Gary suggests asking employees to sign these agreements when you are offering them something they see as very beneficial in exchange.

While presenting restrictive agreements at the point of hiring is best, Maria Forbes suggested such agreements might be added when offering additional responsibilities the employee would see as advantageous to their career, or when realigning roles making the employee's role more engaging and satisfying. Maria emphasized "Ultimately the thing that will keep people from leaving the company is when they are feeling fully-engaged, and they truly love what they do every day."

LEVEL Management Partners takes a very holistic perspective on value creation. Enterprise value growth can come from every corner of a business, including Human Capital. Every action that improves the performance of a business has a positive effect on value, though all actions do not drive value growth equally. Business owners should prioritize their investment in value growth initiatives based on ROI (Return on Investment), maximizing value growth per dollar invested.

While ROI will be different for each company, performing early, proactive Human Capital Planning aimed at business continuity, risk mitigation and employee engagement is certain to be proven a compelling investment for savvy business owners looking to maximize enterprise value.

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