Don’t Let Bored Employees Derail Your Deal
Addressing workforce disengagement has become an essential part of due diligence. Here's what middle-market M&A principals and advisers can do to tackle this important issue.
Employee disengagement costs the U.S. economy hundreds of billions of dollars each year in lost productivity and missed opportunities for corporate innovation. For investors and acquirers, it presents a challenge during M&A due diligence with the power to affect purchase decisions and valuations, or even trigger legal action.
Research shows that many employees are bored, apathetic and frustrated in the workplace, which has negative implications for a company’s profitability and its ability to remain competitive. No business is going to reach its full valuation potential with workers who don’t have their heads in the game, and no buyer wants to pay to acquire a firm with disengaged staff.
Understanding the challenges that employee disengagement creates for due diligence is an important step toward mitigating risks. So is fostering a culture of innovation within an organization before it’s put up for sale.
Culture of Discontent
Fewer than 30 percent of Americans say they’re at least “somewhat satisfied” with their work and career paths, according to a December 2016 Gallup poll. The other 70 percent are “somewhat or highly dissatisfied,” often because they don’t feel challenged, paid or appreciated enough, or they suffer from low morale and lack of purpose.
This reality has implications for mergers and acquisitions, including how deals are structured, post-closing integration, strategic due diligence, valuation, fairness opinions and more.
Distracted and dissatisfied employees aren’t catalysts for creativity and productivity, nor are they devoting themselves to driving long-term shareholder or enterprise value. They aren’t thinking about ways to work more efficiently, collaborate with team members, or improve product and service offerings. If that attitude is entrenched within an organization, it becomes even harder to fix: A disengaged manager is unlikely to spend time thinking about how to improve employee engagement.
On the other hand, firms that consistently demonstrate corporate innovation are typically viewed as dynamic entities. They’re prepared to take advantage of new business opportunities and are more willing to deviate from prior strategies and business models. These companies tend to attract higher valuations in private financing, M&A transactions, strategic investments and initial public offerings.
• 31.5% of the U.S. workforce say they’re engaged
• 51% say they’re not engaged/disconnected
• 17.5% say they’re actively disengaged
Source: Gallup 2016 State of the American Workplace Poll
Buyer Beware
Human capital challenges in M&A transactions are widely acknowledged. They range from the complex web of federal, state and local employment laws and regulations, to retirement and compensation issues, and succession planning, to name a few.
The issue of employee disengagement, which has only recently been acknowledged, presents a new challenge in M&A and investment due diligence.
Post-closing synergies and integration success are highly unlikely when one or more of the buyer or seller’s human capital assets are underperforming or feel underappreciated. Leaders on both sides of the transaction, as well as their advisers, are often in denial about the extent of the engagement problem, or they lack the strategic tools to fix the issue.
During pre-transaction mock due diligence exercises, sellers should prepare for questions about employee engagement, or lack thereof. Buyers and their advisers need to develop strategic due diligence skills around those concerns.
In the future, activist shareholders and other affected third parties could potentially take legal action against buyers and sellers who ignore employee engagement levels and overall cultural performance in their due diligence—particularly if poor company performance post-closing can be tied to the company’s disinterested workforce.
“The issue of employee disengagement, which has only recently been acknowledged, presents a new challenge in M&A and investment due diligence.”
Fostering Innovation
Even before a decision to sell, companies can breed a culture of “corporate innovation” by establishing ways for employees to act as entrepreneurs—to think creatively and implement change regardless of their seniority within an organization.
That said, without the right kinds of controls, firms that foster corporate-innovation activity could generate interesting opportunities that may not advance the business itself, according to “The Handbook of Business Strategy,” which addresses the topic of innovation.
One example of a company that has undertaken engagement efforts is Google, which recently came under fire for its handling of an employee memo about gender issues in the workplace. The event raised issues about free speech within the company (the author of the memo was ultimately terminated).
Yet the technology giant has a strong historical track record of fostering employee engagement through connectivity and idea sharing. Its Google Cafes serve as venues for employees to interact across their day-to-day team, while Google Moderators act as a management tool to allow anyone within the company to posit questions. Through the Moderator channel, employees can view ideas, questions and suggestions from their colleagues. This forges a symbiotic relationship between innovation and employee engagement.
For decades, workers in companies across the country were expected to know their jobs, do their work, keep their heads down, and only “bother” management with questions to avert a crisis.
This approach must shift if companies want to improve engagement and increase innovation—and, ultimately, shareholder value. Employees at all levels should be comfortable asking “Why?” and “What if?” They need to be able to ask—without retribution or punishment—why they’re doing things a certain way, and whether there’s a better way to do them. Empowering teams to ask questions also demonstrates humility among leaders, showing their willingness to admit that they don’t have all the answers and including employees in the process.
What Can M&A Principals and Advisers Do?
- Strengthen HR- and culture-related due diligence analytical skills and approaches
- Bring in subject matter experts and specialists as needed
- Focus on engagement issues in pre-due diligence mock reviews
- Understand connections between high levels of disengagement and the impact on other aspects of business model operations (customer service, innovation, recruitment, brand, social media, etc.)
- Work with legal counsel with strong labor and employment skills and strategic understanding of disengagement issues
- Closely examine the alignment of reward/compensation systems with workplace performance and engagement
- Advise buy-side engagement clients on the risks of acquiring low-engagement companies
- Look for disengagement warning signs in due diligence from the seller (dysfunctional leadership, high turnover rates, an excess of negative posts on job-related websites and other platforms, lack of succession planning or obvious protectionism in leadership positions, declining rates of profitability, lack of innovation, etc.)
- Challenge buyers who think they have the magic elixir for curing cultural or employee performance defects on a post-closing basis (“Oh, this won’t be a problem once we buy them…”)
Andrew J. Sherman is a partner and chair of the corporate department in the Washington, D.C., office of Seyfarth Shaw, and a top-rated adjunct professor in the MBA and Executive MBA programs at the University of Maryland and Georgetown University Law Center. He is the author of several books, including “Harvesting Intangible Assets,” “Franchising & Licensing” and “The Crisis of Disengagement,” published in January. He can be reached at asherman@seyfarth.com or 202-828-5381. Follow him on Twitter @AndrewJSherman.
