Improving Human Capital Due Diligence for Mergers & Acquisitions

Improving human capital due diligence for mergers & acquisitions.

When it comes to mergers and acquisitions (M&A), tangible assets frequently overshadow the intangible — yet critical — asset of human capital. Representing the capabilities, knowledge, and expertise of an organisation's workforce, human capital holds the key to sustainable growth and the mitigation of post-acquisition risks.

So, why is it so easily overlooked? Traditional due diligence practices  are extremely limited. Improved due diligence processes that provide human capital insights, integrate human capital value, identify opportunities for risk mitigation and shape M&A outcomes more effectively, lead to long-term success.

Here’s how organisations can improve due diligence.

1. Engage in real discussions.

Acknowledging that some M&A situations prevent access, In-depth discussions with the leadership team and key staff of the target organisation are often undervalued and underutilised as a source of insight. Yet, they often contain game-changing insights into the company’s people, culture, and ways of working that drive true value. While traditional surveys are usually not feasible during the M&A process, it is sometimes possible to engage key members of the staff in real discussions with the purpose of gaining deeper insights.

The benefits.

• Determine how human capital is valued. Ask pertinent questions to uncover what binds the organisation together, where leaders place (or misplace) their value, and identify the people who significantly contribute to the company.
• Identify cultural & IP Risks. Potential risks related to attrition and intellectual property can be identified early on. Additionally, a baseline understanding of the organisational culture can be established, which is crucial for integrating the acquired entity smoothly.

2. From Org charts to Organisational Network Analysis.

Mapping organisational charts traditionally involves outlining the formal, hierarchical structure of a company (departments, roles, and reporting lines). While this is necessary, it tells acquirers very little about human capital value and therefore is only partly useful.

A network map is a visual representation of the collaborative relationships in an organisation - formal and informal <insert link to forbes article> Having a network map will show the acquirer how the organisation really works, what the critical roles are, which individuals are essential for operational and strategic success and where the future potential / room to grow really is.

The benefits.

• See skills, experience & knowledge. Get a granular view of what the collective workforce brings to the table. Reviewing individual CVs or LinkedIn profiles can provide even more insights into individual backgrounds, experiences, and qualifications.
• Uncover leadership & team capacity. Discover whether the leadership team and key staff are in roles that fully utilise their experience and potential, whether they’re in the right role at all, or have capacity to contribute beyond their current role.
• Identify risk & growth potential. Consider the leadership team's capacity to support growth aspirations, and uncover whether existing team dynamics are contributing to, or stifling, expansion capabilities. This helps identify areas needing additional support or restructuring.

3. Examine leadership preferences and styles.

Insights into the leadership team's preferences and styles reveal a lot about the culture and what staff may be experiencing in the day-to-day. It also aids in making more informed decisions regarding the acquisition and helps identify potential challenges and opportunities in merging the two entities.

It is often easier to extract these insights in an investment setting rather than acquisition setting by conducting personality assessments. Over and above that, it is possible to explore decision making protocols and any staff feedback via 360 and engagement surveys and Glassdoor research.

In an acquisition setting, as this survey data is typically not available or up-to-date, insights can only be obtained in a limited way from discussions with the leadership team and key staff.

We should also focus on cultural alignment <link to my culture measurement page on the website> - this again is next to impossible via a survey in acquisitions but again can be gleaned by discussions with leaders and key people - the case study at the end of this article illustrates this.

The benefits.

• Explore cultural compatibility. Assessing how leaders prefer to work offers a glimpse into the organisation's culture. This compatibility check ensures that leadership styles align with those of the acquiring company and the planned strategy or could easily be aligned.
• Attain deeper insights. Personality profiling tools and (where possible) strategic interview questions around working preferences and leadership styles provide valuable information that may not otherwise be attained.
• Review decision-making styles. Understanding leadership preferences helps in predicting decision-making patterns (how decisions are made and the primary considerations in making them) post-merger — crucial for stakeholders who depend on stability and predictability and leading to improved insights on organisational culture and subsequent change activities.

4. Understand career aspirations.

Understanding career aspirations of key staff is critical for retention strategies and risk mitigation. Interviews are ideal here. The goal is to determine whether the acquisition or integration poses risks or opportunities for retaining critical staff (essential individuals for value creation within the organisation) and how the future organisation might retain and engage them.

The benefits.

• Uncover motivators. Motivators can indicate how well a person will adapt to a new environment. Then, you can start working on how to retain them, or how to adjust without them. You’ll also understand how their career goals can be aligned with the new direction the organisation is taking.
• Smooth team integration. Understanding career aspirations can ensure the smooth integration of teams and safeguard M&A investment by retaining the people who are instrumental in driving the organisation's success.
• Implement effective strategies. With the right knowledge, companies can design and implement retention strategies that mitigate risks while aligning individual aspirations with the strategic goals of the merged entity.

5. Assess individual performance and potential.

Despite its importance, assessing the performance levels and potential of leadership teams and key staff is often extremely difficult during the due diligence process. Even when performance ratings are available (rarely the case), they may not provide the depth of insight needed. Despite the challenges, performance data is critical and should be sought.

The benefits.

• Identify strengths & weaknesses. Identifying the brilliance and blind spots of core staff helps acquirers plan for human capital investments such as restructuring, rewarding, coaching, or professional development.
• Predict future performance. Assessing potential helps predict future growth and development possibilities by finding high performers and identifying who could become a high performer with the right opportunities and support.
• Understand fit & contributions. Evaluating how well staff, including new hires, fit into the company's culture — and how they contribute to it — reveals much about individual values and behaviours.

6. Assess attrition risk.

As noted in our earlier article, Human Capital assets - unlike other assets - can simply walk out and not come back! <add link to earlier article>

A detailed attrition risk assessment outlines factors that can influence the risk of key personnel leaving an organisation. Understanding and addressing these risks is vital for strategic planning, especially during times of significant change (like M&A activities).

Gaining these insights can be achieved through a relatively simple process:

1. Understand what key roles are in the business.
2. Understand and request whatever market mapping for compensation has been undertaken.
3. Conduct research to highlight where skills might be in high demand or where issues of over and underpayment to market might exist.

The benefits.

• Understand market demand and compensation(external). Acquirers/ investors should benchmark salaries and incentives against the market. For example, an engineer paid well below the market rate or with high-demand skills is a high attrition risk. If retaining certain skills is crucial, plans should be made accordingly. As importantly is understanding market demand for certain roles. For example, that same engineer may be well paid to market but have skills that are rare but in demand, the process of ownership change could be the trigger for them to take the call from a recruiter.
• Pinpoint those with critical IP (internal). Losing individuals with critical knowledge of the company’s IP or who understand the organisation's workings can also mean that knowledge is lost.
• Find relationship holders (external ). In some organisations, losing a single person with critical supplier or client relationships can jeopardise the entire business. Like IP experts, directly targeting and retaining these individuals should be a priority due to their irreplaceable value.
• Locate "culture carriers” (internal). These individuals (who often aren’t in top positions, but are highly respected and influential) are critical in maintaining and influencing the organisations culture and engagement. Their departure would have a significant impact  — and potentially lead to a domino effect of resignations — so recognising and retaining these people is crucial for minimising attrition. (Network analysis provides a great starting point).

7. Determine the ‘notional value’ of key roles or staff.

This theoretical value (rather than a cost or salary) estimates the importance or impact of each role on daily operations, success, or value creation. With a notional value, companies can gain insights into which positions contribute most to organisation’s objectives. Notional value can be assigned to key roles or staff, as well as to teams or bands within the organisation.

To gain an insight into how this can be done - and the potential insights (and ironically) value it creates take a look at this McKinsey article: https://www.mckinsey.com/capabilities/people-and-organizational-performance/our-insights/linking-talent-to-value

The benefits.

• Support strategic decisions. Core decisions, such as resource allocation, recruitment, opportunities for synergies, investments to generate improved organisational efficiency, and identifying key areas for investment or development can be supported by calculating and understanding notional value.
• Highlight valuable teams & roles: Uncover what percentage of the overall value created by the organisation can be attributed to each key role or team. For instance, roles or teams that are critical for generating revenue, maintaining customer satisfaction, or innovating new products would be assigned a higher notional value.

Case study: A success story from a real estate funds management firm.

Note: For confidentiality reasons, the real name of the company featured in this case study has been replaced with a pseudonym.

Background.

Part of NexGen Capital’s business launches and manages investment funds that support sustainable real estate projects and technology companies innovating in this space.

NextGen Capital identified an opportunity to invest in a tech firm offering a platform that integrates data from various building management systems to improve efficiency and reduce carbon footprints. NexGen’s aim was to acquire a 50% stake in this firm, which, despite having a promising product and a talented team of 30, lacked the capacity to scale and realise its full potential.

Engaging Rutherford HR.

Before engaging us, NexGen had completed standard due diligence steps. These included examining the product, finances, leadership team, and market opportunities, how the investment aligned with their existing portfolio, and how it could benefit their client base and existing asset portfolio. In this analysis they had followed a more traditional human capital value approach to due diligence.

With existing connections to NexGen, and all-too familiar with the pitfalls of neglecting the human element, we advocated for a deeper investigation into the investment. After recognising the importance of cultural fit and staff retention for success, NexGen began a partnership with Rutherford HR.

Modern due diligence for greater insights and improved outcomes.

Contrary to traditional financial and product-focused due diligence, we led NexGen through a modern, extremely compressive approach to due diligence. Our guidance, and the subsequent strategic interventions, led to a host of positive outcomes.

• Comprehensive interviews with every employee helped NexGen understand their backgrounds, perceptions of the organisation, engagement levels, and aspirations. Our role as advisors to NextGen enabled increased comfort from the target organisation and their leaders, due to our independence from the investment decision making. In turn this generated increased openness and insights.
• Organisational analysis of the company's culture meant NexGen could identify key personnel at risk, and understand the organisation’s challenges and opportunities.
• Risk identification led to uncovering outdated employment contracts, ill-defined incentive plans, retention risks and potential liabilities.
• Talent development and retention strategies, including targeted development programs and coaching for critical staff, supported the retention of essential talent. Over 18 months, there was only a minimal employee departure, significantly below industry norms for M&A.
• Future organisation structure - our insights into  employee aspirations - especially those identified as being of high value and or retention risk and our understanding of business objectives, enabled us to provide advice and influence the future organisational structure - facilitating better integration and value realisation post-acquisition.
• Significantly reducing potential liabilities was possible through legal and contractual revisions where NexGen made the  investment conditional on the target organisation updating employment contracts and resolving legal issues in advance of any investment agreement.
• Strategic recruitment assisted in hiring key positions, including the head of business development and CFO, to strengthen the company's leadership and operational capabilities ahead of time.

Elevate your M&A strategy with improved due diligence.

Harness the true value of human capital with Rutherford HR.

It's time to shift focus from tangible assets to the invaluable asset of human capital. Understanding and integrating the human capital aspect into your M&A strategy can significantly influence outcomes for the better.

Contact us to uncover actionable strategies for understanding human capital value and set your organisation up for long-term success.

https://www.rutherfordhr.com/services/due-diligence

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