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Hindsight is pointless

The due diligence phase provides the opportunity, not just to learn more about the true value of the target, but to begin the planning of the important transition during the post transaction period and to shape some of the consequences of the acquisition structure. Michael Riley, Lead partner at Pinsent Mason, advises.

Due diligence exercises are often seen as something of a chore and teams are despatched to data rooms to generate reports as a matter of process, the focus being centred on the identification of major risks. Whilst this may all be virtuous, experience suggests that HR teams frequently pass over the wider opportunity which the due diligence phase offers, not just to learn more about the true value of the target but to begin the planning of the important transition during the post transaction period and to shape some of the consequences of the acquisition structure.

Hindsight, it is frequently observed, is a wonderful thing. Whilst it might be unavailable to the ordinary mortal, the next best thing is to develop the capability for foresight when making business decisions. The due diligence process is all about having a good look around the target to test the claims of the seller; and about whether the buyer really wants to buy and if so on what terms. That is the focus of an orthodox due diligence report. But the HR practitioner is concerned with “the people piece”, so whilst there is an aspect of the purchasing decision to be considered in this context, there are wider questions to be answered about how the HR footprint of the target will fit with the buyer’s existing business and issues around the potential impact of different acquisition structures on HR issues, such as whether and how TUPE will apply. So whilst due diligence may be largely the province of lawyers and accountants, there should be HR representation on the due diligence team. Experience suggests that the early involvement of HR on the deal team is important if the acquisition is to be a success.

Undue reliance is sometimes placed on the inevitability that the legal documents which govern an acquisition will be full of warranties and indemnities to protect against any undue consequences arising from the shortcomings of the target by comparison with what was expected at the time of the acquisition, but this might misplaced comfort. It may be that the seller is not in a position to give warranties and indemnities or it may be that the seller is subsequently unable to meet any liabilities to which it is committed. Moreover, the warranties and indemnities may not be drafted in such a way as to catch whatever subsequent concern is unearthed. Legal battles to try to recover from the consequences of a purchase which falls short of expectations are never attractive – so the value of the due diligence exercise should not be underestimated. Whilst warranties and indemnities may be seen as an opportunity to redress the implications of what has gone wrong, due diligence may be seen as an opportunity to avoid the problem in the first place.

The first aspect of the exercise is to ensure that the disclosed data covers all that the buyer wants to see. Bear in mind that due diligence is essentially a voluntary process – the scope of the disclosure is a matter for the seller and the extent to which the seller is prepared to make disclosures is bound up with the extent to which the buyer is pushing for material to be made available and the dynamics of the sale process. Bear in mind that the buyer may well be circumspect about the extent of disclosures given that it allows a non-genuine buyer to take a good look around the workings of a competitor, a dangerous situation whatever the confidentiality restrictions which are in place. There are no fixed rules about the contents of data rooms, but they are frequently under populated in terms of HR data. It is for the buyer to drive this process by supplying appropriate information requests, bearing in mind that the guiding principle behind an acquisition is caveat emptor, buyer beware.
The HR part of a data room tends to be dominated by two sets of data. Firstly, standard terms of employment; and secondly spreadsheets listing employees and setting out basic data around length of service, payroll cost and benefit entitlements. This is valuable information, of course, but the HR manager involved in due diligence should be looking to dig deeper. The onus is on the buyer to stipulate to the seller what additional information regarding the target it wishes to see.

There is a frequent practice of engaging HR managers in the acquisition team at too late a stage to make the optimum impact. There should be full HR involvement in the due diligence exercise and those involved will need to be well briefed on the acquisition strategy and the possible implications of the acquisition in terms of post merger integration. Is the buying looking to acquire a “people business” in which the skills of the employees – or certain of them – are critical? If so, attention needs to focus on incentives to stay and deterrents against leaving. The spreadsheets should give some idea of churn and hence a snapshot of the likely attrition rate in terms of key skills. Comparing rates of pay against market norms will be important, but questions should also be asked about the incentive package – bonuses, share options and the like.

The value of these is one factor. Another is the extent to which benefits are deferred, so as to create a lock-in whereby employees are deterred from moving in order to collect the benefits of the plan. By contrast, if the integration strategy is likely to involve changes to the workforce to achieve economies of operation or scale, attention needs to focus on the extent to which contract terms allow for flexibility and whether there are enhanced redundancy schemes. The latter can increase redundancy costs many fold and might be a poison pill which the buyer will not want to swallow. There might be a written policy containing such terms – a staff handbook would be a good place to look; or it may be a freestanding policy. Yet more digging may be required, for such policies are sometimes unwritten but are of contractual effect by reason of custom and practice. This can be difficult to unearth and reliance may have to be put on warranties and representations at a later stage if enquiries are not yielding suitable replies. Some clues may be forthcoming from asking to review compromise agreements or other information relating to recent departures.

Another area which is frequently under represented in the data room is the industrial relations piece. Buyers should ask to review copies of collective agreements and should consider the extent to which there are procedural fetters on making the sort of changes at the sort of speed which may be contemplated. It is important to understand which trades unions are recognised and to reflect on the extent to which that environment will fit well with existing recognition arrangements – or whether the acquisition would be a recipe for inter-union strife. The exact implications of the acquisition wuill depend on the structure chosen. Where there are issues, it may be that the early understanding of these issues and an evaluation of the options may allow problems to be circumvented – for example by choosing a structure which includes or avoids the implications of TUPE.

The buyer should take control of the due diligence exercise and need not feel constrained by the information which is provided. A more imaginative approach to due diligence is to look beyond the data room. Substantial amounts of information are available within the public domain. The target itself may have published a lot of information on its website or in freely available annual reports. Information may be gained about the industrial relations environment from internet news searches and from blogs. These are all valuable ways of gathering information.

HR practitioners usually find the judgements of recent tribunal decisions to be enlightening. These will usually give a picture of how issues have been handled and will give a picture of the extent to which the incumbent HR team and management are managing the workforce effectively and may say something about the inherent manageability of the workforce.

The buyer should be wary that, through the due diligence process, it is acquiring information about the target and should take action as a consequence – ideally as part of the decision making process around whether to buy and at what price. That knowledge will rest with the people who are charged with the exercise and it is important that it is passed on and evaluated. The knowledge may not be properly understood by those in receipt, which is a dangerous position to be in. The possession of knowledge may mean that reliance on a subsequent warranty is not available, as was the case in Eurocopy plc v Teesdale [1992] BCLC 1067 and in Infiniteland Ltd v. Artisan Contracting Ltd (UK) plc [2005] EWCA Civ 758.

HR teams should therefore see due diligence exercises as a valuable opportunity to look into the future, to understand more about the workings of the target – its virtues and the likely liabilities – but more particularly to think and plan creatively about the process of integration post acquisition, to plan to “hit the ground running” once control of the target has been secured, and to secure a smooth integration of the target’s human resources, which is likely to be crucial to unlocking the value in the target. Experience suggests that HR teams do not always exploit these opportunities to the full and a proactive approach to the opportunity is greatly to be recommended, seizing the opportunity and challenging the available information.

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