Incorporate HR Into Your M&A Valuation Methods

When we talk about M&A valuation methods, it’s common to think about the financial and operational considerations that will underpin the valuation process.

But it’s important not to overlook the crucial role that your HR team can and should play in any M&A valuation.

Why? Because employees' skills, experience, and institutional knowledge are critical to the innovation, productivity, and long-term success of a newly merged company.

When we consider that most M&As fail because of poor people management, your HR function’s role in the M&A valuation process starts to look even more critical. Specifically, the issues that are most likely to lead to failure include:

Incompatible cultures
Mis-aligned management styles
Poor communication throughout the M&A process
Loss of transparency and trust

So, should we be paying more attention to the role of HR in the M&A valuation process? We think so. In this blog post, we’re going to take a closer look at some of the ways your senior leadership team can and should be placing HR at the heart of your M&A valuation methodology.

Ensuring talent retention

Understanding and properly valuing the skills and abilities of the employees in a company you're considering merging with or acquiring is vital. Your HR team has a pivotal role in this process, as they are the ones who delve into the talent pool of the potential partner company.

Within the context of the M&A valuation process, this involves assessing what talents exist within the company, examining how people perform their tasks and work, and looking closely at plans for future leadership.

Of course, this is not a one-size-fits-all approach, and it needs to be tailored to the industry and the specific company you're dealing with.

For example, let’s say you're considering a merger with a firm that offers professional services or consultancy services. Your HR team may need to review how many billable hours the other company typically has, what feedback they are getting from their clients and what their future plans for partnerships are. Evaluating these factors would give your leadership team a deeper insight into the true worth of those who are generating revenue for the firm.

Without this objective assessment, it’s more likely you’re going to undervalue the key talent in the company you’re merging with or acquiring. And undervaluation makes it less likely that you’ll have strategies in place to retain the key talent who can help you generate revenue and, ultimately, guarantee long-term success.

Evaluating compensation and benefits

It's critical to fully comprehend a target company’s compensation structures, benefits plans, and incentive schemes as part of accurate M&A valuation.

HR due diligence and analysis can quickly uncover potential costs, liabilities, and risks associated with employee retention.

For instance, a company with salaries below the market average and negligible bonuses may experience high staff attrition during integration, making your retention strategies more expensive.

Think back to when Facebook acquired WhatsApp in 2014. To retain WhatsApp's co-founder Jan Koum, Facebook offered him a massive retention bonus in the form of stock grants valued at nearly $2 billion, vesting over a four year period.

On the other hand, a company with generous retirement benefits might entail considerable future commitments, affecting the valuation differently.

HR can also pinpoint opportunities for inter-organisational synergy, such as merging similar healthcare plans.

Through a comprehensive upfront examination of costs and risks associated with compensation, HR ensures these factors are appropriately considered in the valuation. This not only increases the chance of accurate valuation but can also increase the likelihood of a seamless integration process.

Conducting cultural due diligence

Corporate culture is, in many ways, the fabric of a company. It shapes everything from the daily enthusiasm of its team members to the quality of customer interactions.

During the M&A valuation process, HR functions can play an essential role in beginning the cultural due diligence process that should continue all the way through the M&A process.

Mergers and acquisitions can bring together companies with very distinct cultures and org charts.

Let’s look at an example of a more traditional financial institution acquiring a fintech startup.

On paper, there is a lot of strategic alignment between the two companies. However, the older, legacy financial institution is more likely to have a hierarchical team structure, while the tech company is more likely to have a flat, but more openly collaborative team structure.

Here are a few examples of HR strategies that can help to identify future roadblocks at the valuation phase.

Surveys

Surveys capture employee insights on work values and practices, highlighting cultural commonalities and differences, crucial for M&A valuation.

Focus Groups

Focus groups provide a deeper understanding of employee sentiments, uncovering specific cultural integration challenges and solutions, contributing to valuation accuracy.

Direct Conversations With Leaders

Direct conversations with leaders assess vision alignment, leadership styles, and change readiness, shaping the perceived value and success of the M&A.

Forecasting training and development needs

It’s often overlooked that the value of a target company’s investments in employee training, mentorship, and professional development can be a significant factor in its overall valuation.

During an M&A valuation, your HR function can assess these programs by examining their costs, participation levels, and their effectiveness in skill enhancement, knowledge preservation, and career progression for employees.

Let’s imagine a larger company acquires a smaller manufacturing firm renowned for its comprehensive apprenticeship program that reliably produces skilled technicians.

In this example, HR would assess and evaluate how apprenticeships and applied learning can boost the firm's value by reducing employee turnover, ensuring a steady flow of skilled labour, and avoiding the financial and operational impacts of knowledge gaps.

Evaluating the benefits of such initiatives is crucial in M&A contexts, as it can identify opportunities to upskill your inherited workforce and close skills gaps in the future.

Anticipating compliance issues

Your HR function is the most likely to have a deep working knowledge of employment laws, labour rules, and drawing up compliant contracts.

This expertise will be vital as you seek to forecast the possible financial risks that could affect a company’s value during the M&A process.

Your HR team can ensure compliance with wage, benefit, and workplace safety standards, preventing costly penalties later on.

This is particularly important during cross-border M&A deals. An understanding of international labour laws is crucial for accurate risk assessments and assessing how transferable liabilities such as pensions and benefits could affect the valuation process.