M&A challenges – employee engagement and retention

December 2022  |  FEATURE | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

December 2022 Issue

Retaining and engaging talented employees is a major challenge for any company in the normal course of business. But for those engaged in M&A, it is on another level.

Despite the various geopolitical and financial challenges buffeting the global economy in recent years, M&A activity has remained robust. Global activity in the first half of 2022 remained resilient, according to EY. With 2274 deals at a combined value of $2.02 trillion, dealmaking in H1 2022 may have declined year on year – down 27 percent by value and 18 percent by volume – but activity was up 35 and 13 percent respectively compared to the average of the last M&A cycle.

Given the number of deals being executed, millions of employees the world over are being directly impacted by M&A.

When two worlds collide

Of course, widespread organisational change is never easy on individuals, but M&A-driven change has the unique characteristic of making employees feel like the ground is shifting beneath their feet. Many aspects of a company’s corporate culture and identity will be called into question.

Employees may experience both positive and negative emotions when going through a merger process, depending on how business leaders run the show. Fears of job elimination are typical. A lack of clarity about the future of their role can cause anxiety and motivate individuals to seek alternative employment. For Wesley Shelton, an associate at Proskauer Rose LLP, one of the biggest risks in any M&A scenario is that management or other key employees of the newly acquired business will resign, leaving a formerly high-performing business – or worse, an already distressed business – with no one to do the work. “Especially in today’s tight labour market, retaining key employees after the deal closes must be a top priority,” he says. “Managing employee anxiety and feelings of job insecurity is critical to retaining talent.”

Ultimately, failure to effectively communicate with the workforce can undermine employee engagement and leave organisations vulnerable to losing key talent. In the view of David Teigman, a partner at Proskauer Rose LLP, employee retention is pivotal to an M&A transaction for most industries and companies. “It is the rare transaction where employees are not central to the deal strategy,” he notes. “To improve retention of employees in an M&A transaction, companies should focus on effective communication with the affected employees. Answer the questions you can, follow up when you say you will, and be transparent. This approach will help foster trust between the new employer and the employees. For the most essential employees, consider retention bonuses to help effectuate a smooth transition.”

Many issues can cause a merger or acquisition to fail to deliver anticipated value, and an inability to retain key employees is certainly among them. Aligning employees from two separate organisations on a unified culture can be very difficult. A 2019 study by the MIT Sloan School puts the average attrition during the first year of acquired company employees at 34 percent versus 12 percent for hired employees. With staff turnover likely in acquired companies, it is unsurprising that many deals struggle to achieve their intended objectives.

But there are a number of steps companies can take. Due consideration must be given to the structure of the combined organisation, roles and responsibilities, reporting relationships, and how employees will be rewarded going forward. By adopting a holistic approach to talent retention, organisations are more likely to retain critical talent without overpaying for it.

Financial incentives and drafting agreements

Retention plans covering all elements of the employment value proposition should be prepared for key members of the team. Acquirers will take into account an individual’s key skills, as well as market and industry knowledge. Offers and incentives need to be enticing enough to keep an employee with the company. The employee’s role should also be clearly defined, including whether it will change in the future.

Although the importance of a retention strategy varies from deal to deal, financial retention programmes can be a critical element of a holistic talent retention strategy during times of uncertainty, such as M&A or a business restructuring, according to Daniel J. Doron, a principal at Jackson Lewis. “A retention strategy is particularly important on the sell-side where there are employees whose extra effort will be required during a transaction but who might not otherwise participate in the transaction proceeds – and who may, further, face uncertainty about their future employment with the company,” he says. “Keeping such employees engaged through the transaction process is vital to maintaining momentum and to avoiding the significant disruption that could occur in the event of a departure.”

Retention agreements can play a critical role both during and after a transaction. According to WTW, the most common retention tool remains a straightforward pay-to-stay approach, which was used by 84 percent of respondents to its 2020 M&A Retention Survey. These typically take the form of a time-based (as opposed to a performance-based) cash bonus, rather than shares or options, and are denominated as a percentage of base salary as opposed to a fixed amount.

“There are many permutations of such agreements, which depend heavily on the context,” explains Mr Doron. “Thus, before putting pen to paper, it is important to begin with a clearly defined objective. It is also important to establish the expectations for the employee’s future employment with the company post-closing – or, alternatively, to acknowledge the uncertainty and bake into the agreement a measure of protection; often, a ‘double-trigger’ severance payment in addition to a ‘single-trigger’ retention payment.

“We generally advise that each payment of severance or a retention bonus be conditioned upon a valid release of claims by the employee,” he continues. “Above all, when crafting a retention incentive, it is imperative to put oneself in the shoes of the employee receiving the agreement and consider how it will be received. For example, if the agreement is dripping with heavily qualified language speaking to the company’s discretion, the employee to be retained may well perceive the promise of the retention benefits to be illusory.”

According to Mr Teigman, retention agreements, including incentives, can be vital for retaining key personnel. “A retention agreement may utilise several tools to encourage employment continuity, including stay bonuses, annual bonuses and staggered equity awards,” he says. “A stay bonus provides key personnel with a cash award if they continue their employment for a specified period of time – usually three to 12 months after the deal closes. An annual bonus, payable only to those employees who remain employed after the end of the fiscal year, is another common retention tool, and also part of many companies’ generic compensation programmes.

“Finally, employers can make key employees feel vested in the success of the company, and encourage retention, by granting them equity awards that vest gradually over time. One important drafting tip for any retention agreement is to include a clear termination for cause provision by which non-performing or toxic employees can be dismissed, without the obligation to pay any amounts under the agreement,” he adds.

Welcome aboard

After the deal closes, effective onboarding of the new employees from the target company is a key aspect of the acquisition, and often presents its own unique challenges. These employees are not necessarily ‘choosing’ to join a new company; rather, they are having a new company and culture foisted upon them. The human resources (HR) department will play a key role, and should show some empathy and patience when onboarding new employees. Bringing a degree of personalisation to the process can help smooth the transition for new team members and introduces them to the culture and values of the organisation.

Meanwhile, more traditional onboarding tasks, like payroll, benefits planning and training, can be completed with the help of technology such as automation. This can save the HR team significant time, allowing them to dedicate more of it to engaging with new staff members on an individual, face-to-face basis.

“For asset deals, in particular, it is important to focus early on the block-and-tackle of onboarding, and to include appropriate covenants in the purchase agreement to facilitate onboarding,” suggests Mr Doron. “Further, a solid onboarding strategy requires an intimate knowledge of the workforce and workplace. Things like the number of shifts, availability of meeting space, and even vacation schedules can all be important considerations for an effective and efficient onboarding programme.”

Having a well-structured and detailed integration roadmap, which lays out how functions and teams will come together, is also important. When two companies combine, integration proceeds at varying speeds. For instance, administrative functions may be integrated more quickly than sales teams. To that end, a clear roadmap can help acquired employees understand how they will be brought into the organisation and provides context for their onboarding experience.

It is imperative for the health of the combined company and its employees – whether they pre-date the acquisition or came over as a result of it – to create a positive culture and, for acquired employees in particular, a positive onboarding experience. In this way, the company can reduce turnover and create a sense of belonging across the organisation, which in the long term may have a direct impact on the ability to realise deal value.

Of course, the coronavirus (COVID-19) pandemic has intensified the issue of employee retention and engagement over the past few years, and created shock waves for employers and employees alike. The ‘great resignation’ has further highlighted the challenges. A merger or acquisition process will certainly bring these issues into sharp focus.

As Mr Shelton points out, perhaps the biggest change caused by the pandemic was the dramatic alteration in where and how employees perform their work. “Many managers were surprised to see that employees worked just as effectively from home as in the workplace,” he says. “For many employees, they too learned to appreciate the convenience and flexibility of work from home.

“Anecdotal evidence indicates that a steadily increasing number of employees are returning to the office,” he continues. “However, flexible work arrangements, such as a hybrid workweek by which employees may choose to work from home on certain days of the week, or extended leave to work from home for new parents or other employees with special needs, are now common. At least for now, a mandatory five-day work week in the workplace seems unlikely to be the norm for all employers.”

Companies will need to address the problem of employee engagement and retention in the post-COVID-19 landscape. Tough financial decisions will have to be made. Retention programmes with a financial incentive tend to be most successful, but companies should be selective and strategic when allocating the retention pool fund to ensure the budget is not exhausted prematurely.

Well-crafted retention incentives can help acquirers secure key talent and keep their priorities in focus. This can be critical to the future of the combined company post-transaction.

© Financier Worldwide

BY

Richard Summerfield