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Including ‘Human’ Assets in the Due Diligence Process

Buying a business? Lots of time and resources typically go into due diligence process. Appraisals get done on real estate, buildings, equipment, while accountants and lawyers try to get a healthy assessment to support the business’ financial statements. Often shortchanged in this process is sufficient due diligence into the organization’s ‘human’ assets, and the resulting costs or exposures of change.

Picture this:

Two highly successful, intelligent investors targeted a small manufacturing business ripe for acquisition. One investor had significant experience in manufacturing operations and looked forward to turning the organization around. Hundreds of hours, and thousands of dollars, were spent on due diligence associated with real estate, buildings, equipment, balance sheet and income statement items. In addition, significant time and resources were spent in the negotiation and development of a workable selling agreement.

From the time the negotiation process started, some of the organization’s key ‘human’ assets started to unravel. The lead engineer and primary product development specialist, responsible for 40% of this business’ revenue and client relationships, became fed up with the situation and walked out the door. He was told, or led to believe, he would someday be president of this small firm. Angry with the seller, distrustful of the buyer, principle and pride became his driving force. No amount of money would keep this person around even on a contractual or consultative basis.

Twelve years of institutional knowledge and key client relationships just walked out the door. Now what was the business worth? What risks did the sellers now face, especially in light of the fact they never had their key employees enter into any form of non-compete agreement?

As you might expect, the buyers keyed in on this misfortune and continued to spend time and money renegotiating price and conditions of sale. More resources were spent, only to come to the conclusion that the business value now being discussed made it an even more attractive option for other potential buyers as well. The deal fell apart. Resources were wasted, hopes were dashed, and everyone went back to their offices to lick their wounds, learn from their mistakes, and move on to another day.

How much due diligence was placed on the human assets of the organization? While access to key employees during the selling process can be tricky, failure to do anything to assess the talent, skills, and ‘will’ of the existing workforce can be risky. Consider the following as part of your due diligence process:

  1. Where do the intellectual property and critical client relationships reside? Is the business protected should key human resources become disgruntled or walk out the door?
  2. Are pay, hiring, and employee benefit practices compliant with laws and regulations? Or are you exposed to claims for unpaid overtime, retirement plan violations, and other technical matters often overlooked?
  3. Are you prepared to let competent people run a successful business, or are you anxious to impose your ‘will,’ your systems and processes without regard to the team’s previous successes?
  4. Who will remain as part of your new ‘inner circle,’ and who will no longer function in key leadership roles after you take over? Do you have a plan in place to professionally manage the change and transition process, minimizing angst and fallout?

Due diligence should clearly include a plan and consideration for expenses and risks associated with the planned as well as unplanned people changes that inevitably occur. These risks may involve separation agreements and associated legal fees, funds for severances, as well as recruiting and related expenses associated with replacing key ‘human’ resources that choose to no longer be part of your team. How you treat those ‘planned’ separations is something everybody’s watching. Minimizing ‘unplanned’ separations should be your goal. You’re establishing your reputation as a new leader of a new organization that others will quickly decide whether or not to join.

In the end, failure to win the hearts and minds of those remaining in your new company may take significant money, time, and emotion to overcome. If there’s one thing we want our clients to respect, it’s this: The number one cause of employment litigation… is to make someone mad. There is nothing worse than a workforce that is angry or who has already emotionally ‘quit’ and remains on your payroll. What do you know about the ‘human’ assets that come with the business you’re buying? And do you have a solid, well prepared plan for change? Caveat emptor!

Michael Tracy is owner and Managing Principal of OMNI Employment Management Services, LLC. OMNI is a human resources/management consulting firm located in Overland Park, Kansas.

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