When you’re contemplating acquiring or investing in a cannabis or hemp company, you closely consider its brand, product lineup, customer base and reputation.
Those company attributes are visible and important, but often they can be secondary to solid leadership in a valuation equation. In every deal we’re involved in, the acquirer makes it a priority to ensure that the leadership – and often the middle management – that made the company attractive enough to acquire are retained after the deal closes to provide leadership continuity.
However, leadership continuity means more than just keeping a few nameplates on C-suite doors. It demands that leaders remain in place to retain and integrate the workplace culture, customer relationships and vendor relationships (as well as a myriad list of other intangibles) to ensure the continued success of an operation.
This is true of all acquired companies generally, and cannabis and hemp companies are not exempt from these realities. This may be even more critical in these industries because of the early stages of the cannabis and hemp sectors.
Key Metrics around Leadership
Admittedly, many leaders of private companies are often owners or significant shareholders, and an acquisition is a natural time for them to cash out (or even to take their feet off the gas under new ownership). Moreover, it’s only natural for an ownership transition to generate lots of uncertainty and froth, as employees cringe when opening emails from new owners, wondering about their professional fate.
That’s all the more reason to make leadership planning part of any acquisition, no matter what side of the deal you’re working on – buyer or seller.
Sellers want to make sure they are not docked for the replacement cost (salaries and benefits) of key team members who might depart and the costs of talent acquisition through a headhunter. Given that these costs can have a negative valuation multiplier effect, the financial punishment can be quite severe. Zapping $200,000 off EBITDA to replace a departing CFO’s compensation package, for example, can lower a company’s valuation by $1.2 million if the company is being valued at 6X.
Buyers want as little churn or disruption as possible as they aim for an operational steady state that doesn’t suffer in ownership transition.
In fact, in the absence of leadership continuity, including a well-developed succession plan, acquirers should consider severely devaluing the company, potentially knocking multiple turns off the valuation calculation. Acquirers should even consider entirely walking away unless they are looking for a lower valuation “bolt on” in a space in which they are entirely comfortable and familiar.
What the Experts Say
Leading executive recruitment firms that we have spoken with understand the importance of leadership succession. One expert said they encounter situations where acquirers will want to see the trailing year’s financials during times when the future leaders of the company had significant authority.
Naturally, if an acquirer likes those financials, they’ll want to keep the leadership that put up those numbers. And if a fraction of that leadership is not going to stay on long after new ownership, those leaders must be replaced by people the acquirer believes have the talent to steer the ship in the future.
Putting a solid team in place can be a long process. As a seller, you need enough time to determine if a particular hire was ill-advised. (Harvard Business Review reports that Fortune 500 leaders have about a 50% success rate on hiring decisions!)
The lesson for sellers is clear: Do not wait until the last minute to install a new team that will remain in place post-acquisition. Leadership is an integral part of the success of the operation that’s being acquired, and they should have been in place with enough time to prove they can continue the success of the operation.
The lesson for acquirers is clear as well: Leadership planning should be a key part of your due diligence; never underestimate its importance.
Bringing on Staff to Run the Business
A question we often encounter: “As a seller, should I be hiring this new manager now if I am planning to sell?”
Our advice is always to run your business as though you have no intention of selling. If you need a new role to be filled, upgraded or replaced, do that as if your business is not in a position to sell. Holding out on hiring key roles, when it is clear they are necessary, will concern acquirers because it will appear as though the payout (multiple of EBITDA) was more important than taking care of the business and that the EBITDA was artificially elevated by avoiding essential costs.
From the acquirer’s perspective, if you know you will be making acquisitions, consider what roles are critical to keep. Often, retention agreements or stay bonuses can be put into place to entice key personnel. However, diligence should include a list of “what-ifs” regarding personnel changes. What if the president resigns? What if the chief science officer decides to leave? How will that impact your ability to successfully integrate and run your new investment?
Communicate the Acquisition
News of an acquisition should not come as a surprise to the leadership of the target company, although it may be prudent to keep the information from rank-and-file employees until a well-planned, sequential announcement strategy is put in place, for example:
Ownership > Leadership > Employees > Customers > Vendors > the Public/Media
You’ll be in damage control mode if this isn’t done properly, and some of the management team might even walk off, resentful they weren’t kept in the loop; others will wonder if they had not been told because the ink is still drying on their pink slips.
Family Involved?
Ensuring leadership continuity and succession planning can have added complications if the business is family-owned and/or family-run. When multiple family members own shares, and some want to leave and some want to stay on, it is advisable that an impartial (non-family-member) consultant be involved in constructing the go-forward leadership team – and that adviser should be vested with some power.
Although “Dad” and “Uncle Bob” might have done a great job building the company, “Junior,” who somehow landed a vice president role when home from college one summer, might not be the executive material that the acquirer wants in place. If a family insists “Junior” be the new vice president of sales and the acquirer isn’t exactly thrilled with that prospect, the acquirer may devalue the company accordingly or lose interest. This is where that dispassionate outsider can step in, preserve the value that is at risk of being lost and get the right leaders installed, ideally long before the company is even offered for sale. Even with structured systems in place, it’s difficult to avoid awkward family conversations. Better to have those conversations early on and not in front of an acquirer in the heat of the sale of your company.
Bottom line: Acquirers should look for a solid and well-articulated succession plan to be in place even before they start drafting a letter of intent. Moreover, the absence of one should raise general concerns that the target company is truly prepared for an ownership transition.
John D. Wagner and Dr. Carl Craig are managing directors of Colorado-headquartered 1stWest Mergers & Acquisitions, which offers a specialty practice in the marijuana and hemp sectors. 1stWest M&A has transacted more than $1 billion in deal values.
