How to detect employee dependency before it blows up your acquisition

Welcome back to part 2 of this week’s topic:

Employee dependency.

(When a business relies on just one or two key employees.)

In part 1, we unpacked the dangers of employee dependency in business acquisitions, and how overlooking this could silently torpedo your entire investment.

Now I'm going to show you practical strategies to detect and prevent this risk during due diligence.

How to determine whether the business has an employee dependency problem

Like I said in the last email, most sellers won’t tell you if their business has an over-reliance on certain employees. It’s a bad look, and they know it could sour the deal.

So the easiest way to suss this out is to actually talk to the employees directly, without the seller present.

Interview everybody at the company face-to-face, have a casual conversation with them, and be on the lookout for warning signs.

(Former employees too, if you can find them.)

Things like:

• Only one person knows how to do (or is qualified to do) X or Y critical task

• The office manager is about to have a baby and she’s planning to step away from the business for six months

• The top salesman is friends with all the company’s big clients. He let slip that he’s thinking about starting his own business, and taking those clients with him

If any juicy office gossip presents itself, dig as deep as you can.

Here’s another big item to watch out for:

You also want to figure out who the company’s clients are loyal to.

Like in the example above, it’s a HUGE red flag if a key employee has a close relationship with a major client, especially if they call them on a first name basis and have their personal cell phone number.

If you’re not careful, these employees will walk out the door and take your biggest clients (and a huge chunk of your revenue) with them.

How to protect yourself from employee dependency

To quote Ben Franklin, an ounce of prevention is worth a pound of cure.

The easiest way to protect yourself is by doing those one-on-one interviews, and getting a clear picture of what it’s actually like to work in this business.

Find out:

• Who runs the day-to-day

• Which employees are essential

• What the relations and culture are like in the office

• Who the power players are

• Whether there’s any knowledge concentration (only one or a few employees knows how to do critical tasks)

• Whether there are any current employment agreements and/or non-competes

That last bullet is a big one.

Employees should have non-compete and non-solicitation clauses in their contracts that they’ll have to sign if they leave. So if that’s not already in place, you’ll need to work with a lawyer to fix that ASAP.

That’s all there is to it!

One last thing before I sign off:

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If you want me to send you these high-quality acquisition and investment opportunities (for free!), fill out this 2-minute survey:

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Onward,

— Ben Kelly