Here at GrowthCatalyst, we like to make things as uncomplicated as possible.
And save time for our clients.
We bring these two values to our views about the things you should focus on if you're considering buying or selling a business. Since there's quite a bit going on in this space right now, it's a good time to "uncomplicate" things.
We're seeing increased activity in M&A primarily as a result of pent-up demand and cheap money. Regardless of (or maybe because of) the global pandemic, there are plenty of business owners looking to sell and plenty of others looking to buy. And in this flurry of activity, our sense is some snap decisions are being made today, which may be regretted in future.
Sometimes, things just won't go according to plan...like for this guy:
Why do we make that claim?
There's plenty of market research about how much of this activity creates its intended result, with one study by Harvard Business Review (HBR) finding that around 90% of acquisitions fail to meet their stated objectives. That's a lot. And it impacts both parties involved - buyers and sellers. But on the surface, buying or selling a business is much like any other transaction in that it rests on (at least) two parties coming together to agree on a price at which they're happy to make a trade.
Clearly, given data from the likes of the HBR study, it's not that straightforward.
Intuitively, most of us know that because in any transaction, a great deal of effort goes into the due diligence process. Sellers tidy up their business for sale, and buyers go through the physical and financial data with a fine-tooth comb. There are negotiations over price, contract terms and all sorts of other items that directly affect "value", and a deal is struck. After all that effort, what happens after the transaction takes place ought to be plain sailing.
Right?
Apparently not.
What are buyers and sellers missing?
Experience and discussions with people deeply involved in merger and acquisition activity make it pretty clear that transactions don't fail because of any lack of investigation into the tangible issues that affect business valuations. What does seem to be given less attention are the intangibles.
Research shows that in 2020, intangibles made up 90% of the value of the S&P500, up from around 17% in 1975.
Much of this shift has come from the increasing focus on the value of the client and employee engagement (some studies point to proprietary technology, IP, patents and the like, but none of that's possible without great employees who are highly engaged).
With that in mind, you'd think they'd attract more of a focus.
What does this mean for sellers (who quite naturally want to maximise the price they receive for their business) and buyers (who also quite naturally want to pay no more than they perceive to be a fair price)?
The client engagement question
It goes without saying that clients are valuable to a business. And those who consistently buy from a business are more valuable than those who don't. But, as one participant in corporate advice recently intimated, it's rare to see any qualitative client information in a data room during due diligence.
We're not talking here about the strength or otherwise of contractual arrangements with clients - that much is relatively straightforward and addressed with legal help. We're referring to information about client behaviour, intent and engagement. Note also, when we use the term engagement, we mean something different from satisfaction:
Client Satisfaction
Client satisfaction comes from doing what you say you will when you say you will.
It's meeting the service expectations of your clients, perhaps often exceeding them.
It means you're keeping clients happy by meeting their transactional needs.
Client satisfaction doesn't differentiate you from your competition because it's easily imitated.
Client Engagement
Engagement is created when you build an emotional bond with your clients.
It recognises that logic makes a client think, but emotion makes them decide and act.
Engagement comes from creating a deeper relationship with a client that is difficult to break.
Client engagement sets you apart from your competition because it's a relationship built on a more personal level.
What are the implications?
On the sell side of the transaction: as a seller of a business, you should think about client engagement as something that adds to the value of your enterprise. Since engaged clients tend to be more loyal because of the deeper relationship you have with them, they not only do business with you repeatedly but also become advocates who love telling anyone who'll listen how great your business is. That's valuable.
To extract maximum value, you need to know not just that clients are engaged but also why they're engaged. Understanding why they became clients in the first place, why they remain clients, and why they refer others (among other things) are important questions. And using the answers to deepen engagement and acquire new clients is important in creating sustainable business growth.
One point worth paying particular attention to is the extent to which client engagement is dependent on relationships with specific people in your business. Key person dependencies are common and need to be addressed to ensure clients are engaged with the business rather than with an individual within it.
An astute buyer will want to know about such issues and is likely to pay more for your business if there's clear evidence of a loyal client base. That buyer may also want you, as the owner, and/or key employees, to agree to remain in the business for a time post-transaction to ensure a smooth transition and minimal client disruption. And that's a fair request for a fair return.
On the buy side: as a buyer, you should ask the seller about the issues we've raised above. You want to be convinced that you're buying an engaged client base - not just one locked in with water-tight contracts since most water-tight contracts have specific end dates. Engaged clients (so long as the transition is well handled) are more likely to remain with the business post-sale rather than use the disruption as a reason to seek out alternative suppliers.
Ask to see evidence that the seller has regularly conducted meaningful client research. That research must point to a high level of understanding about the behaviour and intent of clients and the likelihood of them "sticking".
It would be icing on the cake if the research pointed to client attitudes about change in ownership, though it's a subject most business owners usually don't canvass with clients.
You should also consider locking in owners and key people for some time post transaction to protect your investment (and, of course, contractually bind them to the extent it's possible with non-compete clauses in their new employment contracts).
The bottom line as a buyer? There's no point buying a business that comes with valuable physical assets but whose clients fly the coop at the first possible opportunity. Engaged clients are less likely to do that.
A final word on client engagement to both buyers and sellers...our advice is to avoid relying on a raw "net promoter score" (NPS) as a measure of engagement. While the NPS is great for telling you what proportion of your client base is likely to refer others, it generally doesn't go much deeper.
The propensity of a client to refer others doesn't necessarily mean they're engaged. It's an indicator, but it's not definitive - they might just appreciate that you're the cheapest provider in town, or deliver faster than anyone else. Without deeper client research, the NPS goes only skin deep, so take care.
The employee engagement question
Just as engaged clients represent real value in a business, so do engaged employees.
In our opinion, there's a lot of "noise" around the question of employee engagement, but the hard fact is this: the vast majority of employees around the globe are simply not engaged at work. By some measures, that could be up to around 90% of employees, as we've highlighted in a recent Insights post.
There's also a difference here between satisfaction and engagement:
Employee Satisfaction
Satisfied employees are generally happy with the terms and conditions of employment.
They turn up, get the job done, go home....no more, no less. And they're usually not too much trouble to manage.
Satisfied employees look after clients' needs adequately and are rarely the subject of client complaints.
Satisfied employees will be loyal but only until a better offer surfaces.
Employee engagement
Engaged employees appreciate the extra mile you go in providing terms and conditions tailored to the individual.
They buy into your business purpose (which was often a key attraction to them joining you) and are willing to contribute discretionary effort.
Engaged employees connect with clients and are frequently the subject of client compliments.
They're significant contributors to sustainable growth, are tremendously loyal and are strong advocates for your business.
What are the implications?
On the sell side: engaged employees represent real value in your business. It's hard to overstate the advantages of an engaged team.
That engagement has its roots in the clarity of your non-financial business purpose, which should be front and centre of your employee value propositions. During recruitment, induction and their term of employment, it's purpose that arguably contributes more to employee engagement than any other factor (including salary - studies show over half of employees globally would sacrifice a higher salary for a job in a business where business is demonstrably the driver).
Many business owners and leaders leave engagement somewhat to chance...as long as it appears that employees are happy (very different to engaged), they'd rather not poke the bear. To create and sustain high levels of engagement (assuming you have your purpose embedded in your business), it's important to check in to ensure you know the factors impacting engagement over time. They change and can change rapidly (Covid, anyone?), which makes frequent touch points important.
Rather than an extensive annual engagement survey, we recommend regular short-form surveys allowing your employees to formally provide "live" feedback you can act on. And act on that feedback you absolutely must, even if that's letting your team know you can't deliver on a particular suggestion or initiative (also letting them know why that's the case).
These are issues an astute buyer will ask questions about, so be prepared with the answers. And be confident that engaged employees are justification for a premium price.
On the buy side: employees present the most significant integration challenge in any acquisition.
"Culture" (using whatever definition you like) is almost always cited as a key reason when an acquisition fails to fire.
As a purchaser, it's in your longer-term interests to explore engagement levels in the target business. Look for evidence of understanding of the level of engagement and what's contributing to that. Some good questions are:
How does the level of engagement in the target compare with those in your own business?
If higher, what can you learn and transfer into the combined business?
If lower, how do you address that?
Do you even know engagement levels in your own business? If not, perhaps you need to look into it...
The real challenge starts post transaction...because the usual reality is there'll be some crossover of roles in the combined business. Therefore, a level of attrition will be inevitable. To state the obvious, that needs to be handled well, or it can bring the entire transaction unstuck.
Because of a natural bias bred from familiarity, when roles overlap, the buyer of a business will lean toward retaining employees he knows and let go those from the acquired business. It might be a convenient decision, but often it's the wrong one.
It's also important to understand who the high potential employees are on both sides of the transaction and nurture them. Do what you can to retain them because they're generally highly engaged and can help you drive longer-term success.
As a buyer, don't be tempted to push employee engagement down the list of important considerations in assessing target businesses. The history book of acquisitions is full of stories about preventable culture clashes.
Be balanced in your approach.
Probably because it's more specific and quantifiable, the due diligence process tends to favour examining "hard" assets during the lead-up to a transaction. And frequently, when attention is paid to the client and employee base, it's either inadequate or doesn't get deep into the right issues.
Given the 90% of value statistic mentioned earlier and the prevalence of cultural issues in transactions being less than successful, we'd argue it's in your interests as a buyer to pay particular attention to client and employee issues. You can't run a successful business and create sustainable growth without them.
And for sellers? The same comments apply. Of course, manage your expenses and maximise revenue to the extent possible and practical but don't do so at the expense of client and employee engagement. They drive your value, and prospective purchasers will increasingly look to both as drivers of successful acquisitions.
What about your business? Are you a seller?
Are you in the market to buy a business?
Is your approach to value comprehensive?
Or overly focused on the bottom line?
GrowthCatalyst can help address these issues and deliver what money can't buy: time.
We invite you to contact us to arrange a conversation, face-to-face or virtual.
Alternatively, you can book a time for an initial discussion here.
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