Human risk factors in M&A transactions

September 2016  |  COVER STORY  |  MERGERS & ACQUISITIONS

Financier Worldwide Magazine

Mergers and acquisitions (M&As) offer companies an important source of growth. However, it is imperative that deals are conducted properly, for while a well planned and executed acquisition can boost a company, a poorly realised transaction can be detrimental to both reputation and the bottom line.

Though M&A transactions did lose some of their lustre following the financial crisis, it is clear that given the number of headline grabbing, big ticket deals announced over the last few years, M&A activity has returned to the top of the corporate agenda. This resurgence is born out in a recent report from Mercer. According to the firm’s data, 2015 saw global M&A activity hit record levels, reaching $4.7 trillion last year – a 42 percent increase on 2014.

As such, 2015 was the strongest deal making year on record, and though the clouds of economic volatility and instability have again begun to roll in during the first half of 2016, it is clear that M&A is here to stay. Moreover, with activist shareholders agitating for companies to sell themselves or divest components of their business in a seller’s market, we are likely to continue to see organisations and their shareholders push to generate value wherever possible.

Risk and reward

Dealmaking is an arduous process. From the outset of a merger, the pathway to one company acquiring another is rife with risk. Legal and regulatory, communication, geopolitical and financial risks can all derail a transaction at every turn. Though companies can take steps to mitigate or minimise those risks, if executives fail to plan their acquisition adequately, they may find themselves fighting numerous fires at once. Accordingly, it is imperative that companies plan and prepare for the transaction. Due diligence procedures and pre- and post-merger integration planning is essential.

However, one of the most overlooked and underestimated risks is human risk. Human risks pose an immediate threat to the viability of a merger. They are arguably one of the biggest threats companies face, particularly during the post-merger integration process. Employee retention, cultural integration, staff morale, remuneration, benefits and overall talent management should remain a key focus for companies conducting M&A. How companies handle these risks is pivotal to the success of a deal in the long term, and the combined company moving forward. According to Mercer’s report, more than half (55 percent) of respondents noted that talent challenges will remain a significant HR issue in future M&A transactions.

Human behaviour

Of course, not all companies will face the same human risks. An SME and a global multinational both acquiring a competitor, for example, would not face the same pressures and challenges in the long term. Indeed, the types of people risks vary enormously as a result of a number of different factors, as Nigel Boardman, a partner at Slaughter and May, notes. “The degree of risk varies depending on the industry, the geography, the size and the history of the businesses concerned,” he says. “As an example of this latter, a UK business already owned by, say, a US multinational will have lower human risk on transfer to another US multinational than a previously family owned business passing to the same purchaser.”

Many human risk factors can often be traced back to culture and organisation fit. Professor Gerhard Kling, professor of International Business and Management in the Department of Financial and Management Studies at SOAS University of London, notes that cultural misalignment would not pose a direct threat to the viability of a deal, but it can have a significant impact after the fact. “Cultural integration is usually not a deal breaker as problems tend to materialise after the deal is done,” he explains. “Overlooking these problems is very common and expensive as most acquisitions – about 70 percent – tend to fail in achieving their full synergy potential, which is mostly related to post-merger management.”

Failure to factor cultural shifts and integration issues into dealmaking can undermine a transaction and destroy value for the acquiring company. It can have a corrosive effect on staff – either incumbent or incoming. It can crush morale, reduce productivity and erode profits. Furthermore, failing to factor cultural integration into post-deal planning can lead to a diminished talent pool. Talent flight is a very real possibility which could badly affect a company’s leadership pipeline. When the upward mobility of staff is restricted and vital corporate functions such as succession planning are hampered, companies must act. Retaining key employees is also important to maintain customer relationships, as clients can easily be spooked by a break in internal continuity.

In order to ensure that the transition process is as smooth and incident-free as possible, companies should establish a well-resourced integration management team. This team can help to smooth the process of cultural assimilation. Learning and understanding how a company operates is one challenge, but understanding how its people go about their day to day work must be a cornerstone of any acquirer’s due diligence procedures. Geographical or social differences can be just as striking as differences in working style, so it is vital that buyers identify and address these issues in their integration plan.

A successful integration team should articulate the strategy and cultural values of the newly merged organisation, up and down its corporate structure. It should also identify and protect the organisation’s core operations outside the scope of the integration process. Furthermore, the integration team should develop and customise the firm’s integration structure and approach, determining the key integration leaders across the organisation and outlining ways to communicate such plans throughout the company.

Companies need to do their homework. To this end, due diligence plays an important role in M&A, providing acquiring companies with a comprehensive view of their target’s internal workings. However, some companies approach due diligence too lightly. “Due diligence can be treated as a formal process with junior staff performing ‘tick the box’ exercises with inadequate guidance or supervision,” says Mr Boardman. “It should not be like this for any department, including the HR function. One key way of improving due diligence is to learn from mistakes. While it is quite common to have a post transaction review within a couple of weeks of closing a deal, the quality of HR due diligence will not be apparent so quickly. Reviewing the success of HR due diligence 12 and 24 months after closing a deal and feeding the lessons from that review into future due diligence exercises is much more likely to yield quality tangible improvements.” This post deal analysis allows companies to understand the processes they have put in place in the past, and ensure that they factor the lessons learned into future deal integration planning.

Role of the HR department

Companies pursuing a deal should not consider the human risk factor in isolation, away from the rest of the dealmaking process. It requires a holistic approach, assessing human capital issues alongside other, more traditional concerns such as finance, operations and IT. Human resource teams must play a key role in defining and implementing their company’s integration plan. Acquirers tend to develop their integration plan as they move from one M&A deal to the next. Key issues such as organisational structure, employee retention, culture assessment and communication initiatives must be taken into account when drawing up an integration plan. No longer is it simply the task of the HR department to arrive late in the day to address any lingering pensions issues. Rather, HR is beginning to gain a seat at the top table, providing input into the deal driving team and influencing the transaction.

But in order for HR departments to be fully effective, they must be enfranchised by senior management. This, argues Mark Herndon, president of M&A Partners, will allow HR to properly contribute. “In our view, HR has one of the most difficult, and certainly one of the most important functional roles required for M&A success,” he says. “Unfortunately, many HR teams are ill-equipped and not invited to the party until entirely too late.

“Consider that HR has at least four essential roles in M&A success, and only one of them relates to integrating or rationalising the post-closing HR organisation and function. First, HR must contribute strategically to enterprise integration by effectively advising the integration executive and executive committee on all human factor matters, for example talent retention, alignment of compensation and benefits and regulatory compliance matters. Second, HR must support other business groups and functional organisations with core HR capabilities related to integrating or rationalising each of the other functions, for example staffing, reorganisation and downsizing, issuing and managing offers of employment and consolidating diverse job descriptions and seamlessly executing payroll. Third, HR is typically a key subject expert and contributor to essential value-driver initiatives and change management processes required for integration, for example communications, new employee on-boarding and training and culture. Finally, HR must do internally what it is helping every other function and business unit to do: get its own house in order – usually simultaneously with these other essential roles and initiatives,” he concludes.

Furthermore, engaging HR to tackle questions around cultural integration and other human factors will allow executives outside of HR to focus their attention on other, more conventional issues. Financial executives, free of considerations surrounding culture and integration, can concentrate on conducting thorough and effective financial due diligence, risk assessments, investor relations, and ways in which the newly merged entity will create shareholder value.

The early involvement of HR brings many benefits, in terms of helping to establish post-merger cultural integration programmes, as well as effective communications strategies. “We like to see the organisation’s most senior HR M&A expert involved as an adjunct or dotted-line resource for corporate development as early as possible, even helping with prospective target screening, running the HR and human factors due diligence from the outset, and directly advising the deal team and executive committee,” says Mr Herndon. “This same person is then in an ideal position to iteratively complete additional ‘integration-related due diligence’ once the major deal points are worked, and then launch, train and guide their respective HR integration team members.” Yet one of the biggest advantages to the early engagement of HR professionals is their help with talent retention. Ensuring companies can hold on to their brightest and best is a key function of the HR department, helping to manage one of the most costly human risk factors plaguing M&A transactions today. HR can also help to clarify the types of professionals the newly merged company is looking to recruit.

Talent management

Irrespective of their standing within a company, most people do not like change. Embracing uncertainty can be a difficult process for many, whether they are in the C-suite or on the factory floor. Regardless, companies need to ensure that staff are able to transition smoothly into the newly merged entity. HR undoubtedly has a key role to play in managing this process. Having the right talent in the right position within the newly merged company can keep it on track to achieve its desired results. The ability of individuals to embrace change is a key area of focus which companies cannot overlook. Doing so can lead to declining organisational performance with a detrimental effect on post-transaction value.

Furthermore, an acquirer should perform a thorough assessment of its own as well as the target’s talent pool, to determine the scope of strengths and abilities. Knowing the skills, numbers and geographic location of staff allows organisations to evaluate the cost synergies required to make the transaction accretive and drive future value.

Conclusion

For companies pursuing a merger or acquisition, many factors must be taken into account. Among them is the idea that human risks may have an impact on the price of the deal in question, though, as Professor Kling notes, that impact will vary significantly from deal to deal. “Human risk factors affecting the standalone value of the target will depend on the industry and business model,” he says. “For example, in retail banking, human risk factors are of minor importance, as people leaving the target will not affect value. However, in certain areas, such as investment banking or private banking relationships, human risk matters much more. Hence, human risk factors can be crucial. Fundamentally, acquirers have to think what they are taking over – assets, client contacts, people – and assess their value to the organisation.”

Employee retention, cultural integration and leadership concerns should clearly form part of the thinking for companies engaged in M&A. The importance of these issues will only increase as acquirers continue to recognise that people related risks are key drivers for value creation. A holistic approach to human risk factors must be adopted. Whether it is cultural integration, talent retention or the role of the HR team, it is imperative that organisations apply connected thinking. Neglecting any one aspect of these human risk factors can cause deals to collapse.

Reducing or eliminating human risk factors in M&A transactions requires people to buy into the deal. If employees are not on board with the strategic, financial and operational details of a transaction, the deal may wither on the vine. Acquirers must identify the business critical staff they hope to retain to ensure the post-deal phase proceeds smoothly.

Throughout a transactional process, there are more than enough factors which could, if not addressed, scupper a deal. Every effort should be made to ensure that human risks are not ignored.

© Financier Worldwide

BY

Richard Summerfield