We find that for many of our clients, particularly those with family-owned businesses, a decisive due diligence question is how their employees will be treated after the sale of their business.
Despite recent stock market volatility and current uncertainties facing dealmakers, mergers and acquisitions (M&A) professionals anticipate continued acceleration in deal flow in 2019, according to Deloitte’s sixth M&A trends report. In Deloitte’s report, only 21% of respondents anticipate a flat-to-down year for M&A ahead, compared with 30% a year earlier. On the private equity side, the numbers are even more dramatic: only 12% predict flat-to-down activity – less than half the 25% that had anticipated a slowdown a year earlier.(1)
As the active M&A environment continues, many lower-middle-market business owners will consider a possible transaction. While financial parameters of the deal is often one of the driving factors influencing owners, for many of our clients, particularly those with family-owned businesses, a decisive due diligence issue is how their employees will be treated.
What will happen to their jobs?
In the past, the sale of a business often meant job losses – mostly attributable to redundant operations and efforts to boost efficiency. As a result, many M&A deals have inherent retention issues resulting from negative attitudes often felt by employees, including:
- Uncertainty about the future organizational direction
- Feelings of loss of previous organizational culture
- Uncertainty about personal job security
- Feelings of confusion due to lack of communication
- Survivor guilt due to downsizing of other employees
But today, business leaders acknowledge that M&A efforts of the past have suffered from insufficient attention to the people side of the deal, and they are making a concerted effort to better address these issues.(2)
Certain deals, particularly private equity backed ones, are made for financial and investment purposes and present limited integration challenges. In fact, when a private equity investor acquires a company, a key concern is ensuring the employees, with all their knowledge and experience, remain involved to grow with the company. Often, especially for key employees, total comp is increased post deal, with most PE-buyers installing an equity incentive plan to some or all employees to foster a culture of employee ownership.
Both strategic and financial buyers share retention concerns, leading us to our next question:
How exactly will employees be compensated when the company is acquired?
J. Thelander Consulting, a compensation data and consulting company, recently released its 2018 private company M&A report, which sheds lights on those questions and others related to M&A transactions. Survey participants included private companies and executives who have recently completed a merger or acquisition, on either side of the transaction.
One notable data point is that 72% of executives and 42% of employees below VP level participate in some way in the proceeds of an earnout based on their stock ownership in the company. (3)
To minimize transition risk by ensuring the company runs smoothly and to retain critical knowledge and experience, M&A financial models frequently include a retention plan line item, and the cash added for employee retention is often considered simply part of the “cost of the deal.” In roughly two-thirds of PE deals, 15% to 20% of equity is set aside as incentives for managers (independent of those previous equity owners who elect to roll over equity post-closing). (4)
What can I do?
One of the most critical aspects of employee retention is communication. According to a Mercer study, 75% of executives surveyed said that communicating with employees and harmonizing corporate culture were the most important factors for post-merger integration.(5)
Here are some suggested areas of focus to minimize employee turnover at each point in the M&A life cycle: (6)
- Develop your preferred employment model
- Identify high-performing employees and critical roles
- Develop a retention strategy and designing a retention program
- Obtain program and budget approvals
- Develop a communication strategy
- Develop performance management programs
- Create training programs
- Provide leadership coaching
- Facilitate employee focus groups or round tables
- Develop employee engagement surveys and assessments
- Complete management transition
- Improve communication across entities
- Facilitate complex integration activities
In brief, your human resources are a valuable, integral part of your business. Start early to consider how you will communicate with employees and act assertively to retain the ones essential to your operations. It is almost impossible to communicate too much or too often in the acquisition context.
© 2019 J.J.B. Hilliard, W.L. Lyons, LLC. You may not reproduce or distribute any part of this newsletter without Hilliard Lyons’ prior written consent. We believe that the information in this newsletter is reliable, but we do not guarantee its accuracy, and it may be condensed or incomplete. This newsletter is for information purposes only, and is not intended as financial, investment, legal, or consulting advice.