Beware the rabbit hole: How to get HR due diligence right

When M&A fails, people issues are often at the heart of the problem. HR due diligence is therefore a critical part of the M&A process and one which gives people leaders an opportunity to make a significant commercial impact. People-related costs and considerations can make a material difference to the decision to buy a company and how much you should pay for it so it’s not surprising that the HR Due Diligence workstream is getting ever-increasing focus from M&A decision makers.

Here I’ll discuss key considerations in buyer-side diligence. The same considerations also apply if you are preparing vendor due diligence to explain the HR aspects of a business or carve it out ready for a sale.

There are two distinct tasks in HR diligence:

• Assessing the people-related costs and liabilities within the business to inform the pricing of the business – this could include salary costs, bonuses, LTIP, and pensions.
• Analysing the potential people-related complexities in running the business and carrying out the changes you’ve got planned in the long term – this can include comparing benefit plans, culture and employee engagement levels, and rightsizing the HR function to support the future.

As a HR team, you need to balance these two lines of inquiry in the context of the time and data available, the approach being taken by other diligence workstreams, and the drivers for the transaction itself.

What sort of issues can you uncover in diligence?

The scope of work might be similar on every diligence project initially, but once you start to see the target’s data it can move in very different directions – one company might have no complicated incentive plans and a high employee turnover rate, whereas another might seem to have a great culture and low turnover but a dazzling array of complicated bonuses that will pay out on a transaction. A HR team needs to be agile to react to emerging issues and probe into concerns. These are some examples of where a whisper of a problem might turn out to be more significant:

• Out of date salary figures - particularly in the current inflationary environment, an old salary roll can mean mis-pricing the ongoing costs of the business. Additional out-of-cycle or high pay increases may already have been granted or promised to employees and this needs to be reflected.
• Broad brush employee turnover statistics – without granular data about the number of leavers by location or division, a big retention issue could be masked in a large company by only considering the group-wide employee turnover numbers. The reasons for leaving can also tell a story in terms of cultural issues within the company or health and safety concerns.
• Pension schemes – can be glossed over, particularly where they aren’t reported on the balance sheet at a local level. However, there can be a hidden liability that needs to be considered within the debt adjustments to the purchase price. This is a particular risk in certain countries including Switzerland, Germany, France, and the Netherlands.
• Significant numbers of benefit and policy documents – different handbooks for each small sub-population of employees may mean that there is a lack of harmonisation across the organisation. If you are planning a merger and want to create a single-company mindset, then starting with such a range of approaches will likely make your future plans for the business harder to achieve.
• Lack of coherent data – receiving the current and historical employee information over multiple files with different formats (rather than in a single employee census) could indicate that the business doesn’t have a handle on the employees, leavers, agency workers, absences etc and therefore that these areas aren’t being well managed by the vendor.

These are just some of the red flags you should watch out for. Sometimes they’ll lead to nothing at all but you may find a key commercial issue lurking underneath one of these stones!

Is that a rabbit hole?

Diligence is typically a short process based on limited data and interactions with the target management. A HR team will have in their minds the fact that they soon might have to run this business, build it into their plans and look after these employees. This will naturally lead you to want to ask a significant number of questions about the business to really get to grips with everything you will need to know to manage it well in the future. These questions can increase target time, advisor time and delay the transaction itself by distracting attention from other higher priority issues. Generally, there is only so much future planning you can do during diligence – don’t own before you buy.

These are some tips to avoid the rabbit holes:

• Co-ordinate with other workstreams and the deal team leaders to make sure you are producing the input/numbers they need to make the overall decision.
• Discuss materiality as a team and decide where you can draw a line for this phase? If there is a potential problem but it will only ever cost £1k to fix it in the future, then you can likely leave it for another day.
• As the transaction process starts, sketch out a first view of the future shape of the integrated organisation (at a high level) and use this to help direct the focus of diligence work.
• Sketch out the overall timeline of the deal to signing, then to completion and then to future milestones assuming the purchase does go through. In this context, decide upfront how much integration planning needs to be done alongside the due diligence and how much can wait until you are certain the business will be yours to run.
• Use the meetings with target management to probe into potential issues and get a high-level sense of the HR landscape in the target, rather than diving right into the nuts and bolts of the people processes.

As with all successful projects, it is the planning and objective setting that will help to tailor your due diligence to the question you are considering now, rather than the one you’ll be considering in six months’ time.

Conclusion

Due diligence is a valuable time to learn about the company, but it is important to identify what is a rabbit hole and what is a stone to be upturned. An analytical approach to HR due diligence can help sort through the data and quantify your worries in order to communicate them to the wider deal team. If the deal goes through, HR will be on the front foot later in the process to dive into the topics identified during diligence in more detail, as the rest of the articles in our series will demonstrate!