December 2018 Issue
Retaining talent through M&A can be challenging for both the acquirer and the target company as employees may perceive the deal as a threat.
A merger can create uncertainty about not only the future direction of the combined company, but also job security. Staff may endure ‘survivor guilt’ if they are retained while others are made redundant. Also common are increased stress levels and workload and frustration from a loss of company culture.
Uncertainty can cause employees to become demoralised or disillusioned and may create retention issues. When a deal becomes public knowledge, employees may choose to ‘jump ship’ before the merger can be completed. According to Deloitte, 47 percent of executives leave a newly merged company in the first year of integration, while 75 percent leave by the third year. This can impact business continuity, which is so important when completing a merger or acquisition. An employee exodus can also impose the considerable financial costs of recruiting new employees to replace staff. Furthermore, it can lead to a loss of knowledge and the breakdown of relationships with clients and other third parties, all of which may have serious financial implications.
A mass exit of staff is particularly undesirable given the talent shortage across many industries. This trend is most evident in finance and business services, technology, media and telecommunications (TMT) and manufacturing. According to Korn Ferry, the TMT sector in the UK and Germany could see potential annual revenue declines of $27.7bn and $30.7bn respectively by 2030 due to talent shortages.
Despite these issues, talent retention is often neglected, particularly during a merger. People are a key asset and operational efficiency cannot be achieved without identifying, motivating and retaining key talent. So, what more can be done to ensure that companies protect their human capital?
M&A requires open communication. When deals fail, it is often because there has been a breakdown, such as a lack of information during the pre-merger period, or deficient cooperation and coordination post merger.
Poor communication unsettles a workforce. Rumours create uncertainty, erode trust and impair employee engagement. Staff become demotivated and work quality and the company’s bottom line suffer. It is imperative, therefore, that internal communication is stepped up during the M&A process. There must be a robust and effective employee communication plan in place.
However, for Danny Davis, a partner at DD Consulting, companies need to look beyond communication, and consider mergers more holistically. “The key is that everything in a merger is all interlinked; the issue of people is linked to sales, which is linked to the company’s products, and so on,” he says. “It is not just about getting the people aspect right; it is about getting everything right. If you make big mistakes in other areas that affect people, and lots of companies tackle this issue just from the people perspective, companies might think that if they do better communications then people will be happy, whereas in reality it is more complicated than that. Companies must have a good plan in place, not just for their people but for everything.”
Integration and retention issues
Companies must also have an integration plan in place, including retention agreements. According to a Mercer study, 41 percent of European acquirers offer retention bonuses to employees critical to the company’s long-term success – particularly those with key client or supplier relationships, or with knowledge about essential systems.
A clear strategy is needed to take the company forward post-merger, with the right people in place to lead the company into the future. According to Willis Towers Watson, senior leaders and employees below the executive level with key skills considered critical to the transition are the two groups most likely to be offered retention agreements. Furthermore, high-retention companies are more likely to consider non-executive employees with key skills than low-retention companies.
Companies tend to focus on retaining the company’s leaders, as they are responsible for getting the deal done and ensuring it stays on track once completed. Leaders need to focus on the integration process and achieving the strategic goals of the company, without being distracted by uncertainty surrounding their own future. However, issuing retention agreements to the right people is a challenge. Senior management can obfuscate the process and acquirers may not know who the key personnel are on the sell side. “Acquirers have to figure out who is good and who they want to keep,” says Mr Davis. “They have to establish who is key, and that comes through good due diligence. However, a company selling itself will often try to hide things, so you may not realise who is key. You might identify and keep the wrong people. We have seen deals in which senior people hide the better, junior people underneath them. These junior employees who might have more to offer, may then leave, feeling underutilised or marginalised. It could be a while before the acquirer is able to get into the company, look around and find who is really doing the work and knows what is going on.”
According to an Aon study, only 49 percent of companies reported their leadership and key talent strategy as being ‘effective/very effective’ in identifying, selecting, retaining, motivating and developing leadership and key talent in deals. Undoubtedly, it is an area where improvement is needed, and should be considered as early in the deal timeline as possible, ideally in the pre-due diligence phase.
A retention agreement should cover a number of key areas. It must be tailored to the nuances of the local market, take into consideration severance value and reflect an employee’s seniority and tenure at the company. The agreement should also include any incentives that are being offered to the employee. Further, it would also be prudent for the company to include a vision for its future, as well as any applicable career paths on offer within the new corporate structure.
The relationship between people risks and the financial impact of a deal are frequently not factored into due diligence. This must change. Improving due diligence should be a priority for all acquirers, though this is often easier said than done. “It is really difficult to become better at people due diligence,” says Mr Davis. “There is a trade-off between the amount of money you spend on due diligence and whether you are going to do the deal. So you might not do the deal, in which case you have wasted all of your money on diligence. Other deals are a certainty so you may not need to do a huge amount of diligence. Ideally, companies should do more due diligence and spend more on the process but it is difficult. It is easy to say, ‘the more money I spend, the better due diligence I have, the more time I spend looking at the company the more data I have, and I will be able to make better decisions. I will be able to make better plans and I will be able to buy better’. But in reality it is very difficult to do.”
For any acquirer there are quantifiable and non-quantifiable people risks which should not be overlooked, yet many acquirers fail to include them in their analysis. Human resources can play an important role in the M&A process and should be involved from the outset, helping to identify potential opportunities which may be a good cultural fit for the acquirer. During the due diligence phase of an acquisition, HR may highlight potential headwinds to integration and how to overcome them.
Once the right employees have been identified, acquirers may utilise a variety of techniques to ensure they remain onboard, including retention agreements and financial incentives. According to Mercer’s 2017 report on retaining talent, 71 percent of dealmakers use financial incentives for talent retention as part of their dealmaking strategy and process.
“Once we have identified who is key, we put a retention agreement in place and offer people extra money if they stay for a certain period of time,” notes Mr Davis. “There is then the question of motivating a person – and that is where an intrinsic issue with retention agreements comes to light. For example, if company A buys company B for £6m, company B might promise that the company will grow by 10 percent over the next three years. The acquiring company might offer to pay £4m now and the remaining £2m over the next three years as those promised profits are delivered. In doing this and by locking in the profit, the acquirer also locks in company B’s owners, who might not be up to the task. So, the acquirer has locked that person in and has to pay them a large bonus even though they might be holding the business back, and company A is unable to successfully integrate company B and move the business forward in the manner they had envisaged.”
Culture and identity loss
Cultural differences between the target and the acquirer can create uncertainty at all levels. Differences in the way things are done can be disconcerting for employees, so executives need to analyse culture and identify problems. They need to understand what they are happy with, what they are not happy with, and what might need to change. However, according to Mr Davis, cultural disparities are often used as a scapegoat or excuse to mask more fundamental issues arising from a deal. Rather than admitting to a poorly-conceived merger or owning up to missteps during integration, acquirers have been known to cite ‘cultural differences’ as the root cause of problems, vowing not to repeat the same mistakes on the next deal. “It is used as a get out of jail free card,” notes Mr Davis.
For employees, a loss of culture or a seismic change may drive them away from the merged organisation. For the acquiring company, failing to understand the target’s corporate culture or practices may hinder the integration process and alienate people. Issues such as the company’s policies, rewards and recognition programmes can help create a happy, driven and inspired workforce.
Culture plays a role in determining a company’s success. Creating a new, combined culture, drawing on the attributes of both the target company and the acquirer, may ease the transitional period and ensure that employees from the acquired company do not suffer from a loss of identity as a result of the merger. Human capital is vital to any organisation, and companies hoping to prosper in the post-deal phase must understand this fact.
© Financier Worldwide