What is HR Due Diligence?
During a merger or an acquisition, the acquirer also takes on the human capital of the company. The process of understanding this human side of the target company is termed as human resources or HR due diligence.
Human resources (HR) is one of the most underrated assets of any company. The primary reason for this is that there is no straightforward method to calculate the value of the human resource of the company. One might say that the cost that the company is incurring to maintain the current workforce can be considered as its value. In actuality, that is far from the truth. The main phenomenon here is that people run a company, and they are the determining factor in how good or bad the company is or would be. The people of the company are actually its invaluable resource.
Importance of HR Due Diligence
While conducting a merger or an acquisition, the acquirer will consider all major factors such as the target company’s finances, commercial presence, operational efficiency, etc. However, they fail to conduct good HR due diligence. Let us take a case study to understand the importance of HR due diligence –
In 1998 Bank One acquired First Chicago NBD. The reason behind the acquisition was very clear – they wanted to survive in a rapidly consolidating industry. After the deal, Columbus (acquirer) became the 8th largest bank in the United States and the most dominant bank in Mid-West. However, in the next three years, all the 16 top executives who were picked to run the company had left, and the outcome was not as smooth as intended. This deal was registered as one of the biggest disasters in 1999 simply because the acquirer did not consider the delicate nitty-gritty of HR due diligence. Later on, the company rectified its mistake and gained momentum.
Once we understand the importance of HR due diligence, the next question is – what all is part of HR due diligence? Let’s try to answer that in detail.
Areas of Investigation in HR Due Diligence
The acquirer might want to look into the following areas to fully understand the human side of the target company –
The Employee Pool
This area includes the most basic information about the target company. The information includes –
- Number of employees
- Titles and roles of each employee
- Skillset and talent, etc.
This area is basically understanding the demographics of the human capital of the target company.
Understanding the organizational structure of the target company is very important because restructuring is inevitable at some point after the M&A deal. The structure includes –
- Functional reporting relationships
- Administrative reporting relationships
- Position responsibilities
- Vertical and horizontal levels and departments
- Department responsibilities and inter-department co-ordination
- Physical office arrangement, etc.
Contracts and Terms of Employment
Most companies have contracts in place for their employees. It is important for the acquirer to study these contracts before making the buying decision. These contracts are agreements with employees, and it includes decisions such as – probationary requirements, notice period requirements, lock-in periods, no-compete clauses, etc.
The terms of employment are the terms that the employees are obligated to fulfill. These terms are especially important if the target company is from an industry with strong labor unions.
Compensation and Benefit
Employee compensation is a major cost to the company which the acquirer will be taking over after the merger or acquisition. It is particularly important because this will be a major factor that decides whether the target company will be a good fit for the acquirer. Let’s understand this with an example. Suppose the acquirer is paying USD 50,000 per annum to its sales executive. In contrast, the target company pays USD 70,000 per annum to its sales executive, who works at the same grade and same level. Suppose the acquirer wants to take over the target company. In that case, it either has to increase the salary of its own sales executives or decrease the salary of its counterpart in the target company. This is a delicate balance that will define the success or failure of the M&A deal. Compensation and benefits include the following points –
- Basic Compensation
- Bonus Plans
- Pension plans and insurance
- Leave and vacation policies
- Employee stock options
- Other benefits
Apart from this basic tangible information, it is also important to understand the culture of the target organization and whether it would be a good fit for the acquirer. Without a good fit, there are chances of conflict among the employees of the two companies, which can never result in anything good.
After investigating the human side of the target company, the acquirer has a rough idea of what he is dealing with. Now the question is how all this information will be helpful in making the buying decision. Let’s understand this in detail.
Refer to Due Diligence for learning more about its other types.
How does HR Due Diligence help in Decision Making?
After conducting the HR due diligence once, it is time to ask critical questions. Some such questions can be –
- Are there any major cultural differences between the two organizations that will create major conflict in the future?
- Does the target company hold any multiple year-long contracts with any employees at exorbitant compensation that will be unhealthy for the entity in the future?
- Are there any red flags, such as any pending litigations against employees in which the company might have to pay compensation in the future?
- Is the current human resource CTC matching the acquiring company? Is it sustainable in the future?
An in-depth HR due diligence can answer many such questions. The main goal is that the merger or acquisition is smooth and impacts the acquirer in a positive way.