A recent surge in divestitures underscores a tendency among both buyers and sellers in such deals to underplay certain human-capital elements during pre-deal preparation, a new Ernst & Young (E&Y) report suggests.
Many of the most recent notable companies shedding businesses have spun them off into new entities, including Abbot Laboratories (its AddVie specialty biopharmaceuticals unit), Covidien (Mallinckrodt Pharmaceuticals), McGraw-Hill (its education segment), Pfizer (Zoetis, its animal-health business), Sallie Mae (its consumer-banking unit), Sears (Sears Canada) and Valero Energy (CST Brands, a retailer of transportation fuels and convenience goods).
Starting last year there also have been numerous high-profile carve-outs resulting in sales to new owners: Caterpillar sold its third-party logistics business to Platinum Equity; Cytek Industries sent its coating business to Advent International; Eastman Kodak transferred its health group to Onex; and Health Net Life Insurance sold its Medicare Prescription Drug Plan business to a subsidiary of CVS Caremark.
George Brooks, E&Y’s human capital leader for the Americas, attributes the strong divestiture activity to a perfect storm of factors coming to a head since last year. They include companies buying up low-margin businesses amid industry consolidations, new demand for fast growth in shareholder value, growing interest in shedding debt-heavy businesses because of concerns that interest rates may finally rise, and recent regulatory activity.
Brooks characterizes the human-capital missteps that many parties to deals make as falling into three buckets: things you think will work that don’t, things you overlook, and things you know you should do but still don’t.
The chief thing that doesn’t work as expected has to do with retention. It’s in both parties’ best interests for key personnel to stay with business being divested until after the deal closes, and in the buyer’s case well beyond that. But in its survey of 100 large companies (respondents were a mix of CEOs, CFOs and human-capital leaders), E&Y found that while stay bonuses were the most common retention tactic used, they had the least impact among the five most-used tactics.
Respondents rated their success in retaining employees through deal closing on a zero-to-10 scale, with 10 being the most successful. The average score for companies that used stay bonuses was 7.0. Ahead of that were making managers accountable for retention (7.9), enhanced severance protection during post-close period (7.8), communications on the value proposition of divestment (7.3) and surveys to determine employees’ critical concerns (7.2).
“In these big deals there may be tens of millions of dollars going out the door that may not be worth the expense,” says Brooks. At some companies that have made multiple divestitures, the stay bonus comes to be viewed as an entitlement, and when that happens, it loses most of its retentive value, he notes. “But once you start doing them, how do you stop? How do you tell that next division you’re getting rid of that they’re not going to get the bonuses?”
Another very common element of a divestiture is a transition services agreement (TSA) between the seller and the buyer or new entity, under which the seller provides infrastructural and administrative support for an agreed-upon time period after the deal closes. That may a prudent step for getting a potential buyer (or, in the case of a spinoff, existing shareholders who will get stock in the new company) to sign off on the transaction. But it also may significantly interfere with sellers’ oft-stated wishes to keep deal costs down.
“TSAs are the most costly thing in the world to do, because you have to change your entire company to support an unrelated one that’s not in your core business,” says Brooks. “And deal teams often don’t even realize the effort and cost involved. We have one client that charged a buyer $7 million for TSA services only to find out later that its real cost was $66 million.”
One increasingly popular tactic to cut down on TSA expense is to recast businesses in countries where the buyer currently doesn’t do business as stand-alone entities prior to the deal closing. They create the new legal entities, transfer the employees, set up new bank accounts and satisfy all the requirements to operate in the counties. “That’s better than waiting for the buyer to get all that done or having to rely on costly TSAs,” says Brooks.
But he adds, parties to deals should be aware that when you take employees out of a large company and populate them into a small company, per-person administrative costs will rise and it likely will be tough to get decent terms from vendors of health-benefits, life-insurance and disability policies.
In the “things you overlook” bucket, companies tend to scrutinize the financials of businesses they buy so minutely that they don’t ask enough questions about the people who are coming along with the deal. They may overlook any workforce-analytics studies the seller has done and even give short shrift to the total number of employees that is coming over as well as the number in specific countries.
“The first question a buyer should ask is how many people it’s buying, and how many it’s buying in each country,” says Brooks. Except at manufacturing companies and a few others, people-related costs are usually 60 percent to 67 percent of an enterprise’s overall expense, he notes.
A couple of not-uncommon, pre-closing tactics of selling companies are throwing high-cost, less-desirable employees into the business being sold and pulling high performers out of it. A buyer best practice is to insist on specific, contractual prohibitions of such maneuvers, but the agreements aren’t always made. “It’s amazing what people overlook,” Brooks says.
And there is no excuse for not reviewing workforce analytics. “Companies are always studying things like whether their workforce is too mature and whether they need to change their employee base to get aggregate costs down,” says Brooks. “There are a lot of telltale signs like that, but we’re not seeing a lot of buyers looking into them.”
In the “things you know you should do but still don’t” department, buyers may suffer a critical failure to size up the culture of the business being acquired and determine its fit with its new parent. “People always talk about how important culture is, but almost any time a deal fails, people are blaming the CEO for failing to address the cultural differences,” says Brooks. “You have to think about whether cultural attributes are going to inhibit or delay efforts to attain the synergies you’re looking for.”
A common reason for failure to effectively appraise culture is that “it’s a lot of work and it’s always given to people who still keep their day jobs.” Also, Brooks notes, the culture of an acquired business can easily change quickly if the buyer fires too many people before synergies are realized.