How do you assess human capital risks in M&A deals?

Risks commonly arise from the turnover of key talents. If you're planning to acquire a company and don't take the time to look into its human capital and understand what actually matters to people, you're venturing blindly into the abyss, and history is replete with such examples. During the diligence phase, resources may be scarce, but that's manageable; you can utilize external data on the company, various sources, and even HR data if it's available in the data room. Then, in the PMI phase, you can conduct surveys, etc. However, don't just rely on observation techniques; it's crucial to engage experts in this domain to accelerate the process and ensure focus on the right areas.

In M&A, assessing human capital risks is crucial. As a leader in R&D with global reach, I've seen how overlooked human elements can unravel deals. Key is identifying risk sources: cultural mismatches, leadership gaps, and talent retention. For example, in our acquisition of TechStart, we prioritized understanding their team dynamics and ensuring alignment with our values. It's about peeling the onion—looking beyond the surface to understand the core of the workforce. This approach not only mitigates risks but also harnesses the full potential of human capital, turning possible pitfalls into a mosaic of opportunity.

While turnover is a key metric, consider hidden talent risks. Aon Hewitt reports 26% of high performers leave during mergers due to lack of clarity on future roles. Proactive skills gap analysis using talent assessments during due diligence can pinpoint these risks and inform talent retention strategies, mitigating disruption and accelerating post-merger value creation.

To assess human capital risks in M&A, start by identifying sources like turnover, retention, compensation, culture, and leadership. Utilize tools like surveys, interviews, and due diligence to gather insights on factors such as performance, skills, diversity, and alignment. This data-driven approach informs strategies to mitigate risks effectively.

To address human capital risk in M&A, start with thorough cultural due diligence to understand values, behaviors, and management styles. Develop a cultural integration plan outlining desired attributes and steps to achieve them, involving a dedicated team from both companies. Identify and address cultural fault lines, such as decision-making processes and values, which can cause disruptions. Leadership should exemplify desired traits, and effective communication is essential. Offer cultural training to build mutual respect. Monitor progress through feedback and adjust plans as needed. Celebrate integration milestones to reinforce positive behaviors and motivate employees.

Assessing human capital risks in M&A requires a keen eye to ensure you're not buying a lemon. It's crucial to evaluate the impact of risk by delving into company culture, retention rates, and leadership dynamics. For example, in acquiring a tech startup, we scrutinize the integration potential of their talent pool—ensuring their innovators aren't just part of the package but will drive future growth. This is about peeling back layers, not just checking boxes, to secure a seamless transition and safeguard your investment.

While it is challenging to measure the benefits when human capital integration goes right, the positive outcomes, such as seamless transitions and enhanced innovation, can significantly drive future growth. Conversely, when things go wrong, issues like high employee turnover, cultural clashes, and leadership conflicts lead to immediate, tangible losses, making the impact of human capital risk more apparent and measurable. Thus, a thorough evaluation helps safeguard your investment and realize the full potential of the merger or acquisition.

It all depends on the strategic goal of the transactions. For some, human capital assessments are merely a formality to save face before proceeding with the sale of the target company's essential assets. For others, the intention behind the assessment is genuine. In these instances, the business vertical also needs to be considered. In tech, for example, human capital is always at risk due to the volatility of resources and skills, especially for technologies in high demand, like COBOL, for example.

Quantifying human capital risk is crucial, but also assess its cascading impact. For instance, the loss of top sales talent can result in a 10-20% dip in target revenue within a year. This direct impact on deal value underscores the need for scenario modeling that links specific human capital risks to financial projections, ensuring a realistic valuation and mitigation strategy.

The acquiring company also needs to be mindful of whether and how to execute any resulting reduction in force, which tank morale and yield flight of the acquired talent.

Go beyond retention, focus on redeployment. A Deloitte study shows 72% of executives planned to redeploy talent post-merger. Develop a skills-based redeployment plan to leverage talent from both companies, mitigating redundancy risks and maximizing deal value through innovation and cost savings.

One misconception is that risk mitigation should encompass all stakeholders, from customers to investors. However, to be truly actionable, it needs to be segmented into various plans, each with specific metrics and analytics designed to make the transition as smooth as possible from a talent perspective. A one-size-fits-all plan simply doesn’t work. A concrete example would be conducting a deep dive into team-level mapping to identify who possesses the most firm-specific knowledge, who is most at risk of leaving, and how to retain them. More money? Sure, that's one approach. But what else? Opportunities for growth and improved leadership are also vital. And the process shouldn’t stop there; it should continuously seek further enhancements.

I believe that assessing human capital risks in M&A deals usually involves evaluating factors such as: 1- employee retention, 2- cultural alignment, 3- talent management, and 4- potential conflicts. This can be done through thorough and detailed due diligence, by analyzing organizational structures, assessing leadership capabilities, and conducting employee surveys or interviews. Worth mentioning, the importance of understanding the impact of potential changes in workforce dynamics post-merger is crucial for effective risk assessment.

The final step is crafting a risk mitigation plan. Aligning with deal strategy, it outlines actions, resources, timelines, and responsibilities. Addressing stakeholder needs, including employees, customers, investors, regulators, and partners, ensures effectiveness. Incorporating contingency measures and monitoring mechanisms enhances adaptability and ensures successful risk management.

Effective communication is essential, but tailor it with data-driven insights. Studies suggest merger success rates rise by 15% when communication is aligned with the unique cultural profiles of both organizations. Use cultural assessments early on to craft messaging strategies that resonate, ensuring a smooth transition and rapid value creation.

What matters most is communication. You simply can't over-communicate in these situations. Who enjoys being told what to do without any visibility into future plans? Imagine having a family and no clear direction, or hearing rumors about the company being sold off in pieces. It might seem better to leave before it’s too late. This is precisely what PE transactions need to avoid at all costs. Communicating your strategy effectively is crucial. Doing so at the right time is even better.

To ensure effective risk mitigation, implementation of the plan is essential. Communication and engagement with employees and stakeholders are crucial. Providing clear, consistent, and transparent information fosters trust. Involving them in decision-making and problem-solving processes empowers and motivates. Recognizing and rewarding contributions build commitment and alignment. These actions strengthen organizational resilience and ensure successful risk management.

Monitoring is key, but don't stop at traditional indicators. Measure the speed at which critical leadership roles are filled post-merger, particularly those focused on innovation or synergy capture. Gartner finds a 30-day leadership vacancy can cause a 5% drop in value. Link human capital metrics directly to broader deal objectives, enabling rapid adjustments and maximizing value creation.

The assessment is just part one; then it's time for remediation and action planning. Let’s say you’ve identified a risk related to extensive firm-specific knowledge due to talent attrition. The first step would be to act upon it by communicating and attempting to duplicate access to and knowledge of this data. Retention bonuses are not a solution to all problems.

Monitoring and measuring the results of the risk mitigation plan is crucial. Collect and analyze data on human capital indicators like turnover, retention, productivity, and engagement. Compare actual results with expectations, identifying gaps and opportunities for improvement. Celebrate successes, learn from challenges, and share best practices and lessons learned with the team. This continuous feedback loop ensures ongoing improvement and enhances the effectiveness of risk management strategies.

Continuously adapting risk management is vital in handling human capital risks in M&A deals, which often extend beyond numbers into people, culture & leadership—critical factors for success. Human capital risks evolve with changing workforce dynamics, regulations & market conditions. Staying updated on trends in organizational behavior, talent management, and cultural integration is essential. AI tools are instrumental in analyzing employee sentiment and engagement metrics, offering deeper insights into potential risks. Collaborating with peers & sharing knowledge provides fresh perspectives & innovative solutions. Practical experience is invaluable; each M&A deal offers lessons in managing risks refining approaches for future success.

Very important in assessing human capital risks is determining whether the target company places too much reliance on one person’s skills, presence, name/reputation. We call this 'key person' risk. It's like trying to buy a magic show that only one person knows how to perform. Buyers typically want a business that can run smoothly without the magician. Risk mitigants can include an already well thought out retention and succession plan for the magician, which may or may not be reflected in the transaction structure, e.g., a staged exit over a multi-year period, or some other form of phased transaction once the risk has been mitigated. Key person risks typically apply more to physical businesses than virtual businesses.

Bear in mind, especially as a buyer, that you should not add to the risks, especially avoidable risks. Sometimes buyer orgs think they can easily redeploy people from their org to fill attrition gaps in the target or transplant work from the target to their own team. This will not work if specialized knowledge is being lost (esp. in overhead & support functions, which often are targets for reductions). Excessive changes to target's team composition hurts bonding & morale and it takes time to recover. Be mindful of these situations - buyers can easily avoid them, but overconfidence often causes such avoidable risks to turn into reality