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A company’s policies can make all the difference during acquisition

By Evert Akkerman

Recently, one company decided against buying another because the organization for sale lacked basic HR structure. Specifically, there were no written employment contracts and policies or a formal performance appraisal process.

Many business owners will consider selling their company at some point. They may want to cash in and retire, they may be looking for a new challenge or there may be a lack of potential successors within the company or the family. When a prospective buyer expresses interest, part of the due diligence process is determining the value of the company for sale. When it comes to valuations, the interested party would want to see financial statements, including balance sheets. Among the factors that determine value are buildings, equipment, inventory, AR/AP, mortgages, lines of credit, tax liabilities and cash position. Other factors are reputation, revenue and profitability.

The purchasing company had been interested in taking over a company in eastern Ontario as part of a geographic expansion. One of the components of the seller’s valuation was an amount of $3 million for goodwill. The purchasing company then asked a number of questions about the seller’s workforce. It turned out that the company employed approximately 100 people, whose average compensation was $50,000 per year, with an average tenure of eight years.

The company did not have written employment contracts in place that prescribed the Employment Standards Act (ESA) minimum for terminations without cause. If it had, and a new owner decided to let everyone go, the cost of providing each employee with 16 weeks’ pay-in-lieu would have worked out to $1.5 million. However, since all employees had all been hired on a handshake, reasonable notice under common law would apply instead. The purchasing company, realizing that it was looking at a potential liability of eight months’ pay-in-lieu for each employee, showed the seller that this could work out to well over $3 million. The conclusion: “There is no value there.”

When it comes to hiring and promoting staff, it is important to have a signed employment contract in place before a new employee physically reports for duty. Putting together an offer of employment is the stage where an employer can manage risk. By contracting out of common law, the employer can limit its severance obligation.

When companies hire people on a handshake, the liability for the employer can be substantial when terminating employees without cause. Stating that an employee will be entitled only to the minimum notice prescribed by the ESA helps the employer avoid being on the hook for reasonable notice under common law.

In light of the fact that labour is usually the largest business expense, looking at financial statements and tangible assets is not enough when it comes to valuations. Besides severance obligations under common law, there is the hidden cost of people being miscast and miserable in their roles, people underperforming and being left to flounder, having supervisors who lack management and social skills and thus trigger turnover – you won’t find any of these as a line item on a company’s balance sheet.

When it comes to buying and selling companies, HR can add substantial value for both buyer and seller by putting solid employment contracts, a meaningful performance review process and enforceable policies in place. n

Evert Akkerman is an award-winning HR professional and founder of XNL HR.

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