This is the second in a series of posts to help search fund entrepreneurs evaluate tech-enabled (and more specifically software) businesses. The purpose of these articles is to equip the searcher to ask better questions earlier in the qualification process, and preserve precious time and capital for more qualified opportunities.

In this post, we'll discuss how you can better understand the People in the technology group of your target company. We'll discuss three key areas of risk: Turnover, Knowledge Concentration, and Post-Transaction Churn.

Turnover

It can be easy to fall into the trap of thinking that all turnover in a company is negative signal. To be sure, a company's inability to retain talent should be seen as a warning sign to be investigated. However, lack of turnover within a company can also be a sign of stagnation and unwillingness to deal properly with bad hires. EVERY company makes hiring mistakes, or realizes a year or two in that a particular employee is not a fit long term. 

The other risk you encounter with a team that has worked together for a long time with no new hires is that documentation and processes can be forgotten as a discipline. Everyone knows what everyone else is doing, so no need to write anything down. 

Here are some questions to ask about turnover, along with what to look for in a response.

When was the last time you hired / fired someone?

Having to onboard new engineers on a somewhat regular basis forces the company to write things down about how the puzzle pieces fit together, as well as how the company operates day to day. New engineers also bring fresh ideas and new thinking to an existing team. 

Letting people go who are not a fit shows a commitment to the company direction, even if you may not agree with it. It also shows that the company can sustain the loss of knowledge without putting the company at risk, something we'll explore more deeply in a following section.

What's the average tenure?

Good technologists tend to change jobs and move up every 2-3 years max. They want fresh challenges and to be able to work on new, interesting technology. Long tenure with a company should be accompanied by steadily increasing responsibilities and expertise, as well as diversity in domain knowledge.

Short average tenure as well as stagnation are both warning signs that the company does not take career development seriously. 

Knowledge Concentration

In any small company, knowledge concentration is unavoidable. The question is to what degree and how can you quickly mitigate the risk after closing. Here's a few questions to get a sense of your risk level related to knowledge concentration.

Who Are The Key People You Could Not Live Without?

The classic "Hit by a Bus" question is a great one to ask early in the evaluation process for a couple of reasons. First, you'll get a sense for how the company thinks about business continuity. If the answer to this question is "Susan's been here since the beginning, and there's nothing she doesn't know about our customers and company", it's a sign that the company is likely highly exposed and doesn't put the company interests ahead of individuals, including the founders. Second, if Susan's critical to the picture, a question you'll need to answer early is "Can I work with Susan every day?"

What Tools Exist Within The Company For Sharing Information?

Does the engineering team have a Wiki or common place where system documentation is kept and regularly updated? What internal communication tools are used (Slack, Github, Jira) for managing day to day operations? Does the engineering team meet regularly to share lessons learned or to explore new ideas (lunch and learns, etc.)? In short, is it a culture of continuous learning and improvement?

Post-Transaction Churn

A critical area of People risk is the first 180 days after the transaction. You are at your most vulnerable as a new CEO learning a new business, and the very last thing you need to be dealing with is people churn in the engineering group. Here's a few questions to help you assess the likelihood of post-transaction drama.

How loyal are the key people to the exiting owner(s)?

A great way to tease this out is to ask open ended questions about relationships.

- "Tell me about the last time you had a significant disagreement with Susan on product direction?" 

- "How did you and Susan meet and what's made your relationship work?"

Have any of the key people ever held a gun to your head?

It's not uncommon for someone in a senior position to take advantage of the fact that you're new to the picture, particularly if they feel as though they have all of the leverage. Ask the outgoing owner directly if any of the key people have ever demanded a change (pay, title, etc.) with a threat to walk if not addressed. If the answer is yes, you must have a plan to replace that person as a part of the transition or you will most assuredly suffer the same fate.

How do you conduct performance reviews?

If no one's gotten a raise or had formal performance reviews on a regular cadence, you're likely walking into a situation where people will be looking to you to pay for the prior owner's sins. Furthermore, a change of ownership is typically a great time for everyone to ask the question "Do I want to stick around?" Make sure that employees are being paid at or near market, have had regular reviews, and are advancing in their careers or being moved out.

Conclusion

People risk in engineering is at or near the top of the heap. Unexpected departures (regardless of cause) can reduce customer satisfaction, increase churn and put the business at risk. We've covered a few of the questions here that you can sprinkle in to early conversations with the seller before you ever get to LOI to help you better understand the people you'll be inheriting as well as where you'll likely have to make changes immediately after closing. 

In the next post in the series, we'll cover how to better understand Product risk. Stay tuned!