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How to Evaluate M&A Value of Human Capital

By Micah Lucas
Senior Associate

Growing through acquisition allows leveraging of synergies that most often promise strong revenue and minimized expenses. In addition, acquisitions offer the possibilities of optimizing shared building space, serving a broader customer base, reducing labor costs, and consolidating vendor and third-party services. As buyers evaluate potential merger and acquisition (M&A) transactions through due diligence, value is often unnoticed and potential synergies are missed by overlooking one of a seller’s most valuable assets – human capital. Especially in today’s labor market where most IT skills are in short supply, the value of human capital has never been higher. Buyers know they need technically strong, relationship-based staff to keep service levels high even as new customers come on board.

A formally organized human resources function, whether it is managed inhouse or outsourced, helps buyers understand the real and potential value of the human capital under consideration. For example, a selling organization with clearly thought-out staffing models, pay bands, and employment offerings can go a long way towards its attractiveness to a buyer and ultimately its deal value. Less organized HR functions for both the buyer and seller can extend due diligence and may even risk the transaction.

Assess Technical, Soft Skills Early

During HR-related due diligence, it is important to establish what the acquiring entity will look like post-transaction. Will the larger entity require more sales and marketing professionals? Will the acquiring entity’s HR needs require inhouse HR functions? Which positions will be created or eliminated? Mapping the post-transaction HR structure in advance is critical during due diligence. A key activity of early due diligence effort should include developing a thorough understanding of each role in the post-transaction organization and what each role requires in terms of skills, of which all may not be technical skills. Effectively communicating, having high emotional intelligence, taking an empathic approach, and being able to identify and resolve problems – characteristics which are collectively referred to as “soft skills” – help customer-facing staff build trusted relationships with customers.

Additionally, looking at potential employees’ length of service can reveal insights about the organization’s collective strength of skill set, its ability to scale, and the estimated timeline for expansion. For example, pairing tenured skilled IT professionals with newly recruited staff can create balanced customer service teams as the buying organization expands.

Understanding the skill and talent requirements for each role can identify talent gaps that help clarify bargaining points between buyers and sellers as well. Current, in-demand talent will trump traditional skill sets as the market continues to move away from legacy systems. Today, for example, IT professionals who deliver digital transformation capabilities are more valuable than those supporting sunsetting systems.

Navigating Labor Load Comparisons

A full census of the selling organization and a labor load package for each employee is mandatory for effective HR due diligence. That package should contain each employee’s start date; salary, bonus and incentive history; 401K contributions (individual and company match); and insurance coverage (individual and company expense) and other benefit offerings. With the seller’s labor load packages in hand, due diligence needs to shift its focus to the benefit offerings of the buyer. Profiles for seller’s employees should be created using the buyer’s benefit plan and pay bands. Human capital analysts will compare benefits and compensation to determine if adjustments in compensation and benefits may be needed for newly acquired talent or for the combined organization generally.

It is important for buyers to avoid being misled by a title-to-title comparison of the staff under consideration. Depending on the size and scope of the acquired company, titles can vary widely and not be indicative of actual contribution and potential impact in a larger organization. Is a Level 2 engineer title representing the same skill sets and job functions in the buyer company and the seller company? Does a manager just manage people, or do they also perform a billable function?

Probing Intangibles Identifies At-Risk Employees

Additionally, buyers should ensure that each employee’s job description and performance reviews are a part of the due diligence analysis. It is recommended that managers in the buying organization have one-on-one conversations with any of the engaged managers or directors of the seller (these are seller identified key people) regarding each of seller’s personnel to accurately assess each employee’s consideration for employment as a part of the acquisition transaction. These conversations are likely to reveal the intangible characteristics that separate good employees from great ones. For customer-facing roles, managers on the buy side should inquire about technicians’ and sales associates’ working relationships with customers to determine if each employee’s background and skillset is being optimized in his or her current role. This analysis helps frame conversations for the specific employees of the seller that are offered employment with the acquiring entity.

When the elimination of some staff is necessary, it is critical that buyers not only analyze the staff at the entity being acquired along with their own talent. A common misconception when an acquisition is that buyer’s talent is better qualified and has a wider skillset than seller’s talent. Often, deal value can be lost when the seller’s talent is automatically eliminated when headcount reductions are necessary in a transaction in comparison to eliminating some of the less qualified HR talent of the buyer. In the current marketplace where strong talent is often hard to attract and retain, this oversight can be quite costly.

Cost of Intentional Overstaffing, Turnover

Sellers who stipulate that all their employees must be offered a position in the new organization can be potentially lowering the deal value or make it more difficult to hit certain metrics that impact future payments from buyer to seller post close. For example, a selling organization that staffs to projected revenue will bring less value to a buying organization than the seller who runs lean on staff. However, if a seller has a solid business reason for intentional overstaffing, such as signed contracts that have yet to become active, the case can be made to the buyer that the new organization will be able to accommodate immediate account starts and expansions.

The buyer’s geographic staffing needs to be accounted for in the analysis of at-risk employees as well. For example, if the acquiring company wants to expand to an IT skills desert, it will need to move aggressively to keep that talent on both sides of the transaction as they will be needed in the new region.

Whether you are a potential buyer or an interested seller, don’t leave money on the negotiating table by overlooking the value of your human capital. It may well be one of your most important bargaining chips.