In previous blogs, we discussed the case for HR involvement in M&A activity and what to do when you get the green light. This article will focus on two aspects of due diligence commonly not done well or at all: organizational and operational due diligence.

Most organizations with a track record in executing M&A transactions have developed capability internally or contracted externally for the main areas of focus: financial (including valuation and negotiation strategy), legal, and environmental due diligence.

Organizational Due Diligence

Organizational diligence is usually the responsibility of the human resources department. Of course, their degree of ownership or participation depends on their perceived value to the organization. HR functions with a track record of being strategic partners are always integral to the earliest stages of due diligence. The following examines various components of organizational due diligence. When effectively executed, they can help provide for both a successful transaction and integration:

1. Review benefits programs:

Benefits costs can be critical, especially when acquiring a small-cap company. Some companies have a de facto strategy of porting all acquisitions onto the corporate benefits platform. While this strategy is efficient, passing the costs of a rich benefits program to a small company can erase the deal’s value or significantly impact the acquired company’s ability to meet its business plan. In addition, increasing the cost of benefits for employees can negatively impact retention, particularly entry-level workers who, on a percentage basis, would be particularly hard hit.

2. Catalog and review HR practices:

HR needs to understand all of the relevant organization/people metrics and trends, including any financial, legal litigation, or liabilities (e.g., unfunded pension plans). All HR programs, practices, and policies must be cataloged, such as performance management, human capital planning, talent acquisition, and succession planning processes. HR should also evaluate each in terms of the deal drivers and acquisition integration targets. HR must also conduct a review and comparison of the compensation practices. This review should focus on understanding the cost implications and potential synergy opportunities.

3. Map the cultures of the parent and acquired company:

HR should develop a tool to visually compare and contrast the cultures of the parent and acquired companies. HR should note areas of divergence and then lead the development and execution of a culture alignment plan. This rigor will ensure that the acquired company’s culture aligns with the parent’s business plan and the deal drivers.

4. Evaluate leadership:

One of the most critical roles HR can play is to develop a transparent process and supporting assessment instruments to evaluate the senior management team of the acquired company. Incumbents should be categorized using some typology, such as:

• Strong performers – must retain
• Adequate performers – but need development
• Should be in a job with less scope
• Release immediately (dead weight)

5. Develop a manpower redeployment strategy:

M&As usually cause considerable personnel displacement. Even if your organization has a defined employee severance policy, several channels are available for redeploying manpower. These include skill banks, retraining programs, accelerating natural attrition, offering an early retirement package, instituting “up or out” programs, providing termination “consulting” arrangements, and loaning employees to government or community organizations.

6. Develop and execute a talent retention plan:

A well-crafted plan includes consensus around the definition of key talent. Often, the definition used for the talent management process is insufficient for an M&A. Individuals with difficult-to-replace skills, key customer relationships, or unique technical skills are often part of “key talent”. The talent retention plan should also include a forecast of key talent loss and specific actions for reducing it. (Note: Stay bonuses only delay the inevitable. Research suggests they have little long-term impact on talent retention.)

7. Complete an organization structure review:

Headcount is one of the easiest areas in which to realize cost reductions. HR can often identify considerable cost synergies by analyzing the acquired company’s business model (what is in-sources/outsourced, on-shored/offshored, centralized/distributed) and structure (spans of control, levels, etc.). Early in the process, HR can be instrumental in selecting/confirming the senior and mid-level leadership teams from the acquired company.

8. Proactively address the organizational/change management issues:

Many studies have concluded that only about 30% of M&A deals are successful in achieving stated objectives. The biggest shortcoming is not adequately addressing the change management and people issues such as:

• Stakeholder assessment/alignment
• Communications
• Capability gap assessment
• Organization alignment

Operational Due Diligence

Operational diligence is the lynchpin in identifying where and how specific synergies can be realized. Completing this activity during due diligence gives an organization the advantage of using the 100-day implementation period to realize targeted synergies instead of figuring out what to do. Discussed below are the most critical components of operational due diligence:

1. Complete a facilities review:

Brick-and-mortar facilities represent a potential area for cost savings. Duplication of facilities provides an opportunity to close offices, distribution hubs, manufacturing plants, etc. This analysis can result in revenue realization by selling these assets and considerable cost reductions.

2. Complete value chain review:

A value chain is a visual depiction of an organization at different levels of detail. It’s akin to being in an airplane: If you look out of the window at various altitudes, you can see different levels of granularity. By documenting and comparing different parts of the Parent company with the acquired company, you can quickly identify potential cost savings, areas for divestiture, and outsourcing opportunities.

3. Complete review of your process hierarchy:

This typically involves documenting the process hierarchy of both the parent and acquired companies. HR can collect data around key performance attributes such as customer service, cycle times, headcount, quality, and cost to identify potential synergies.

4. Complete activity-based costing (ABC) review:

Traditional cost accounting tracks cost by work functions/units. Although this provides leaders of a function/unit with the information they need to manage, it fails to identify costs as they accrue across several functions. ABC allows you to identify activity and cost drivers attributable to work that traverses several silos. It provides more complete information to understand how, where, and to streamline operations.

Organizations that rely heavily on their external growth engine typically have strong capabilities in the mainline M&A areas. Organizational and operational due diligence are two levers organizations can use to improve their probability of success.

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