Tackling HR Due Diligence in M&A
During the course of a merger or acquisition, due diligence can provide valuable HR insight into the workings of the company, from employment practices to its talent pipeline. Managing the diligence process to achieve an effective review of that data requires HR partnering with internal teams and managing the review process.
By Shari Yocum and Niki Lee
Due diligence often reminds me of the children's book Where's Waldo? because, while trying to find Waldo, your eyes and attention are drawn in many different directions at once. The due-diligence process can be a chaotic and daunting task for anyone, especially with today's added global complexities. However, it is a necessary evil, because it is imperative that you uncover any concerns prior to buying a company.
There are a number of teams involved in due diligence, each of which look at data through a different lens. As an HR professional, you will work closely with the legal, finance, and corporate development teams. HR will partner with employment attorneys (either in-house or external) to review all employment material. It's wise to sit down as you kick off diligence and discuss the areas that each team will own so as to prevent duplicate work and ensure everything is covered. Your legal team will provide the target with a list of data needed for analysis in the data room. There are a number of due diligence lists available on the web that are good starting points. Over time, as you become familiar with the diligence process, you will likely modify the list to best suit your company.
Most data rooms today are virtual, though every now and then you may still have to go into a law office to physically review the data in a secured area. Regardless of the method, the work you need to complete will be the same.
Diligence time frames vary greatly, depending on the number of countries under review, company size, and the speed at which the target loads data. When planning your time, consider the fact that you may need to have a number of documents translated, which can add one to four weeks to your schedule.
Key Areas to Review
There are three main areas that HR should focus on during due diligence: HR employment practices and policies, talent and culture. Employment practices and policies -- which is a rather large bucket of work -- captures all of the detailed HR work. This is the traditional part of diligence that requires digging through piles of data to gain a grasp of everything happening within the company. Key areas for review include employee contracts, past or pending employment litigation, benefits, compensation, change in control provisions, entity and employment structure, policies, union or bargaining agreements, org charts, immigration and performance management. The goal is two-fold: understand what they are doing and identify any potential risks or impacts to the deal.
It is helpful to request a census with all of the employee details. You can use this to quickly assess immigration status, years of service, and costs. Don't forget about the contingent workforce during your data review. This group can become a pain point from both a cost and legal perspective. It's important to address any co-employment issues (i.e., concerns over the employees being defined as contractors but actually working as employees), or potential termination costs.
If the plan is to restructure any large groups of employees, you will want to breakdown the severance costs and actions required in those countries. Severance costs are often key factors in determining whether the acquisition will continue. Some countries require the company to accrue a portion of pay that will be provided as severance upon termination. It's important to make sure those amounts are funded appropriately because, in an acquisition, you will pick up this liability down the road.
In splitting the review of the employment work, it's best to utilize your legal team to tackle the more regulatory focused issues such as 280g, 409a, pension agreements, equity plans and ERISA issues as well as any employment risks (previous litigation). You are likely to spend time reviewing the change in control agreements with the team so that you are both clear on the financial impacts of the deal relating to employee costs and retention.
The next key area to review is talent. As the HR leader for diligence, you will want to set up time to meet with the CEO and key leaders to talk through the talent in the organization. This should be a small group so that each person is able to speak freely. Walk through their leadership style, what makes a successful employee in their company, who the critical employees are (using the life boat exercise is helpful -- if you could only take 5 people with you...), and any risks or concerns. Use this meeting to watch the actions of leaders and study how others react to the person speaking. Realize that the target is naturally inclined to make everyone sound great so you will need to really drill down to understand why each employee is critical.
In some acquisitions, HR may have limited access to the leadership team. However, each functional leader participating in diligence will likely have a counterpart to talk to during the diligence process. You can provide a worksheet to each of your diligence colleagues to use to capture the "people feedback" they get during their diligence session. For example, you can provide engineers doing technical diligence with a list of questions about the talent so that they can gather the answers during their discussions. It is helpful to meet with the other diligence leads beforehand, since many of them may not be as comfortable or accustomed to discussing talent. And finally, don't forget about using LinkedIn to review your talent and investigate critical employees. Keep in mind that LinkedIn will send an e-mail to the employee informing them that someone has viewed their profile.
The final key area of diligence is a review of the company's culture. Culture diligence has become a normal and accepted part of the process over the last few years. Earlier, it was brushed off by the business, but after numerous articles and real life examples in which acquisitions have failed due to companies turning a blind eye to cultural challenges, business leaders are much more receptive to the discussion of culture. During the diligence process, your real goal is to look at the three layers of culture: the geographical cultural differences, the work style difference, and the business impacting differences.
Most companies will have similar stated values, so you will need to dig deeper to understand how the company really works. Many companies just look at each organizations stated values and come away saying "wow, we are so similar, we both value customer service." However, as you start to drill down into the details, you may find that your approach to customers is completely different- driving variations in the way you budget, manage, and respond within the company. The culture diligence doesn't usually stop a deal but is key for building a long-term sustainable organization in which culture similarities and differences work for and not against you.
Summarizing the Results
You should develop a process that you can repeat each time so that it becomes second nature to you. This will reduce the overwhelming feeling in starting the diligence process. The following are four practical steps for reviewing and summarizing the diligence material:
- Create a working diligence document that captures the following key areas that you will review:
* Data room notes: This section will have a list of the HR dataroom folders and, under each folder name, it will have the document number and the name of the document they have loaded. After you review that document, enter your summary notes. This will help you remember what you have reviewed and any concerns or red flags. This will also later feed into your due diligence summary report.
* Contract review: The second tab is ‘employment contracts," which will hold the employee contract details. When the target company is small, it is easy to review every contract. However, in large transactions this is not practical, so the focus should be on the executives, the standard company agreement and any contracts identified with different terms. It is beneficial to call out all of the details (at-will employment, performance reviews, severance terms, CIC, work hours, employing entity, and immigration) because you will frequently use this information later. This is also where you will identify the change in control terms.
* Follow-up items: This area consists of all of the items that may be of concern or that need follow up, allowing you to keep a record of target responses and decisions.
- Create a side-by-side analysis of benefits and compensation. Depending on the complexity and concerns about the deal, you may also do a side by side in other areas such as policies and contract terms. This work will feed directly into your integration planning and also immediately highlight any concerns or cost differences.
- High level cost analysis: As you wrap up your diligence findings, it is important to highlight any financial concerns. This section will focus on the obligations post-close, the dollar impact of any potential litigation, increases to run rate, and all of the HR-related costs identified during diligence.
- Summarize your findings in a document that has a section for each key area (leadership team, key talent, benefits, compensation, litigation, stock, restructuring, union/collective bargaining agreements, culture, etc). This summary document is shared with the business leaders and cross-functional partners. It's also a key document that you can archive to remember any unique items about the findings of the company. This will help your corporate development team as they finalize the go and no go decisions and can be used as the starting point for your integration planning.
Due diligence can be a busy and thankless job, but it is a critical process that ensures the companies you acquire are the best fit. It also helps reduce problems downstream. The most costly mistakes for HR in due diligence will come through a lack of funding by the target company for benefits (i.e., pensions or severance funds), missed change in control provisions that could be triggered, inappropriate termination or employment practices that could result in future litigation, or poor leadership at the target company. Your thorough and detailed review of the company is the first step to a successful integration.
In earlier years, HR was not always brought in for due diligence. However, it is increasingly considered crucial now to have HR as one of the early members of the diligence team. The work uncovered during diligence will directly feed into the integration strategy.
By using two lenses, a due diligence (compliance) and integration diligence during the process, you will reduce the time needed to build out your integration strategy. It is important to connect the dots and make sure the findings in diligence are passed on to the other HR members as you proceed into the process of integration planning. After much practice and experience, you will be amazed at how quickly you will be able to pick out the "Waldos," and ignore all of the other noise.
Shari Yocum and Niki Lee are managing partners of Tasman Consulting in San Francisco.