Overview

Mergers and acquisitions (M&As) are tools businesses use to achieve organizational
objectives—tools that have profound impacts on the employees of the organizations at
every level as two organizations attempt to integrate into one. A merger is generally
defined as the joining of two or more different organizations under one common owner
and management structure. An acquisition is the process of one corporate entity
acquiring control of another corporate entity by purchase, stock swap or some other
method.

An estimated 70 percent to 90 percent of all M&As fail to achieve their anticipated

strategic and financial objectives.1 This rate of failure is often attributed to various HR-
related factors, such as incompatible cultures, management styles, poor motivation, loss
of key talent, lack of communication, diminished trust and uncertainty of long-term
goals.

This article discusses the importance of managing "people issues" in the context of
M&As, with an emphasis on the role of HR professionals, who must be adept at
recognizing potential problems, identifying solutions and persuading management to
adopt them. The article offers an overview of the five phases of the merger or
acquisition transaction and discusses the business case for M&As. It addresses the key
issues that must be managed in an effort to assist HR practitioners in preparing for the
challenges and practical realities of M&A transactions, including:

 Creation of new policies to guide the new organization.

 Retention of key employees.
 Employee selection and downsizing.
 Development of compensation strategies.
 Creation of a comprehensive employee benefits program.

The article closes with the discussion of the importance of a well-planned

communication strategy and briefly addresses cultural fit, technology and outsourcing
decisions, and global issues.

HR's Role in M&A Transactions

The consideration of a merger or acquisition usually comes packed with mixed feelings,
including excitement, fear, uncertainty, enthusiasm and resistance. These emotional
reactions can occur at every level of the organization. How an organization deals with
its employees before, during and after the transaction can have a determinative impact
on the success of the transaction.
Both mergers and acquisitions present significant challenges to HR professionals. The
M&A process requires management of both organizations to consider all implications of
a proposed merger or acquisition before agreeing to one—which necessarily involves
consideration of the "people issues" created by a proposed merger or acquisition. HR
professionals are often involved in the process by advising management on human
resource matters, including using surveys and other metrics to gather relevant data,
identifying potential conflicts or HR challenges between the two companies, integrating
HR practices and company cultures after an M&A, and managing talent decisions such
as layoffs, to name a few.

HR professionals face a number of challenges during M&As, including:

 Attempting to maintain an internal status quo, or to effect change—either to

facilitate or thwart (in the case of a hostile takeover) a possible merger or
acquisition, as instructed by upper management.
 Attempting to provide guidance to upper management from a "people"
perspective as to whether organizational goals will be better fulfilled in the form of
a merger versus an acquisition, or by making internal changes.
 Assuming that a merger or acquisition has been approved, discerning all aspects
of the two separate organizations and the one combined organization that will be
affected.
 Communicating with employees at every step in the M&A process with both an
appropriate level of disclosure and an appropriate level of confidentiality.
 Devising ways to meld the two organizations most effectively, efficiently and
humanely for the various stakeholders.
 Dealing with the reality that M&As usually result in layoffs of superfluous
employees under the combined organization. This reality entails coordinating
separation and severance pay issues between the combining organizations.
 Proactively avoiding legal issues for violation of federal and state anti-
discrimination laws and the Worker Adjustment and Retraining Notification Act
(WARN).
 Participating in the defense of lawsuits that may be brought as a result of a
merger or acquisition.
 Aligning the HR function to achieve the organization's strategic objectives.
 Addressing the ethical dilemmas involved, in which an HR professional may be
required to eliminate his or her own position, the position of a current co-worker,
or the position of an HR counterpart in the combining organization.

Anatomy of an M&A Transaction

Mergers and acquisitions tend to go through similar phases. A brief summary of those
distinct parts of most transactions follows to familiarize HR professionals with the M&A
process.

Phase 1: Identifying buyers

Phase 1 involves identifying potential candidates that would be interested in merging

with, buying or selling to the organization with the goal of bringing significant
advantages to both parties. It is important to sign a nondisclosure agreement (NDA)
before sharing much information between companies. NDAs are not fail-safe, but they
offer some legal protection and highlight the need for secrecy. An organization's
management must also carefully decide, even with a signed NDA, how much
information to disclose and at what stage of the process. An interested buyer usually
wants to know more than the organization wants to share, and its representatives have
to use discretion at every stage to determine what level of disclosure will intensify the
buyer's interest without harming the business should the deal fall through. An HR
professional may be involved in the process of communicating the need for an NDA,
collecting signatures and maintaining the records.

Phase 2: Securing third-party services

Phase 2 involves the legal, accounting, regulatory and technical aspects of completing
the transaction. It is during this phase that third-party professional services are secured
(e.g., lawyers, accountants, investment bankers and M&A advisors). These individuals
or groups are critical to the success of the transaction and will be involved in the
development of the structure and content of the legal agreement. An HR professional
might be involved in interviewing the third-party professional and negotiating an
independent contractor agreement.

Phase 3: Preparing for the transaction

Parties make sure their teams are briefed, ready and on the same page, and sign a
letter of intent before they begin the due diligence process. It is important for parties to
ensure that their legal documents (e.g., option plans, board of director notes, NDAs,
partnership agreements, benefits plans) are organized and in good shape. Also crucial
is for parties to ensure that they have completed the proper government filings, that they
have adequate product and marketing documentation, and that their financial records
are sound and have been audited by a legitimate third party. HR professionals are likely
to be heavily involved in the collection and organization of such records.

The parties sign a letter of intent if they tentatively can agree on the priority issues
involved in the transaction. A letter of intent is a document that seeks to provide some
initial points of understanding and that binds the parties to keep the information
discussed confidential. This document is signed prior to the start of the due diligence
process and prior to formal board of directors' approval of the deal.

During the due diligence process, it is critical to read documents carefully to eliminate
any surprises that could jeopardize the deal. Parties should decide up front how much
information they will share during due diligence; they should expect to have to share a
significant amount of detail. Parties must have the required documentation organized
and prepare multiple copies so they will not be slowed down by copy requests. In
addition, parties should be aware that due diligence almost always takes longer than
expected.

Phase 4: Negotiations, valuation and final agreement

Regarding negotiations themselves, many tactics are employed, and the right ones
often depend on the types of organizations involved. Different industry sectors use
different valuation metrics (e.g., multiples of revenue, discounted cash flow or EBITDA,
which is "earnings before interest, taxes, depreciation and amortization"). The parties'
financial advisors, both internal and external, generally control this aspect of the
transaction.

Assuming the due diligence process has not uncovered any material issues that cause
a reconsideration of the transaction, and assuming the price seems right, both parties
draft, negotiate and approve the legal agreement. Regulatory and filing issues must be
considered at this time. Despite the prior approval of the parties and their respective
boards of directors, organizations must often take additional steps (e.g. filings with the
relevant secretary of state, taxing authorities and other government agencies with
regulatory authority over either company, such as the federal Securities and Exchange
Commission).

Phase 5: Implementation

In this phase, the two organizations are combined into one. New workgroups are
established, and redundant employees are laid off. The corporate culture for the
combined organization is established and communicated to all employees. HR
professionals may be involved in formulating a new mission statement, vision statement
and possibly a values statement. Organizational policies and procedures will be revised
and coordinated with significant input from HR professionals.

Business Case

As shown above, the business case for involvement of HR professionals at every step
in the M&A process is overwhelming. Studies consistently show that most mergers and
acquisitions fail, mainly because of people and culture issues. In the period leading up
to and immediately following a significant transaction, a tendency exists for employees
to begin considering their own personal situation. Questions usually contemplated
include "Where am I going?"; "What do I want out of both my personal and business
life?"; and "Will I like the new company and its management group?"

The longer the period of uncertainty lasts, the more attractive alternative employment
becomes. To make things more difficult, the best and brightest managers are the ones
immediately targeted by recruiters attempting to lure them to other organizations. The
loss of key employees can seriously erode the potential value of a transaction for the
acquiring firm. Perhaps equally damaging, and just as costly, are those people who stay
on the payroll but who emotionally "check out" and do not perform at their previous
levels of productivity. If the process is not managed well, a company may end up with
the employees who simply had the fewest alternatives.

HR's Involvement Before the Transaction

HR professionals typically play pivotal roles in an acquisition's core due diligence

activity. During due diligence, information about talent and culture—along with typical
assessments of employee benefits plans and liabilities, compensation programs,
employment contracts and policies, legal exposure, and more—can provide insights into
the value of a property and its workforce and can decrease the likelihood of unhappy
and expensive surprises once the deal is complete.

A thorough review of the acquired organization's legal position generally takes place
during the due diligence phase of the transactions. This is a time when all people-
related policies, plans, practices and programs should be scrutinized to ensure
compliance with applicable employment laws and regulations.

In the HR arena, one area that has significant potential for creating issues is that of
retirement benefits. The questions concerning defined benefit plans, defined
contribution plans, vesting, valuation of liabilities and overfunding or underfunding of
plans are complex issues that can create real challenges for members of the HR team.
In addition to a review of retirement-related issues, HR should also conduct a full
analysis of the target company's health care benefits and costs, as well as its worker's
compensation liabilities.

Companies can inadvertently assume significant liability if they do not conduct careful
due diligence before finalizing the transaction. The target company can have pending
charges or litigation from the Equal Employment Opportunity Commission or face unfair
labor practice claims from the National Labor Relations Board. Each of these potential
legal problems needs to be addressed specifically in the acquisition agreement, and the
purchasing company or surviving company may want to secure an indemnification in the
agreement as well. Such an indemnification provision keeps a company from assuming
unreasonable risks, especially if litigation currently is pending. Because the two entities
will be combining into one, to be meaningful, the indemnification provisions are likely to
extend to key officers, directors and shareholders—which again raises "people issues"
that may require the involvement of HR professionals.

While one or two cases of discrimination or sexual harassment can normally be

resolved fairly easily, the HR team needs to be most concerned with examples
of systemic problems created by a lack of appropriate policies or a failure to enforce
those policies. Legal issues that typically cause the most problems include those related
to wage/hour issues, leave issues (including the Family and Medical Leave Act, the
Uniformed Services Employment and Reemployment Rights Act, and workers'
compensation), integrating immigration-compliance procedures and affirmative action
plans.

Key Areas of HR Involvement After the Transaction

The outdated view of HR as a purely administrative function rather than as a strategic

one often results in HR professionals being excluded from many aspects of the M&A
process in which they could add significant value to the process.

Having the necessary skill sets to effectively manage the integration (e.g., knowledge in
employee relations, communications, change management and legal requirements)
should gain the confidence of senior management in HR. Competency in these areas
also should enable HR professionals to handle the complicated process of managing
human resources during mergers and acquisitions. 

Creation of new policies to guide the new organization

To shape the culture of the newly merged organization, the employer must develop and
communicate to employees a cogent people-related strategy. Such a strategy should
include the development of key policies, rules and guidelines to govern employee
behavior and related workplace expectations (e.g., attendance, time off, harassment,
drug testing, privacy).

Retention of key employees

To retain the key talent that will help make the new organization successful,
management should communicate its intentions to the "star performers" as early in the
process as is legally possible. This means requesting access to conduct confidential
interviews with key employees in advance of the actual closing date. Most importantly,
management should be very careful not to undercommit to these key people, or they will
consider other employment options. Star performers know who they are and understand
their personal and professional marketability.

Employee selection and downsizing

Early placement of management is a critical factor in beginning to stabilize the new

organization. Any delays in placing key managers complicate the transition by
increasing uncertainty, diverting attention and fostering internal competition. A major
challenge for the acquiring company is in deciding who to retain, who to redeploy and
who to terminate, as well as effectively managing those processes. Relocating key
personnel or even entire departments may be necessary. 

Ideally, the HR and management teams will have been able to assess the skills,
capabilities, potential and motivations of key employees involved in the merger or
acquisition. Typical methods include interviewing and testing techniques and the use of
outside consultants. Once these tasks are completed, the HR team should take
immediate steps to "re-recruit" and place these employees into key positions of the new
entity. 

Most M&A deals count on both the organizational and financial efficiencies that will
result from a reduction in the number of employees needed to run the new organization.
This outcome means that HR will spend a large amount of time assessing employee
knowledge, skills and abilities (KSAs) to decide who will stay and who will go. The
strategy may include terminations, early retirements and a longer-term plan to simply
not fill certain positions as they are vacated. The ways in which these decisions are
made will—in the long run—be as important as the actual decisions themselves.
Moreover, the manner in which talent management decisions are made will
communicate a great deal about what the organization values.

Development of compensation strategies

Depending on the circumstances of the deal—and the compensation policies of the

combining companies—HR will likely be called on to splice disparate payment plans into
a program that fits the new organization. Alternatively, HR may have to discard the
original plans and then create a program from scratch that meets the goals and
direction of the newly merged entities. Either way, old and new employees will be
concerned about what is happening with their pay and will want full and early disclosure
about the changes being considered.

In addition, members of the senior management team will be anxious to see what types
of special arrangements (e.g., stock options, special retirement provisions, severance
agreements) will be offered to them given the high-profile nature of the new positions.
The development of an executive compensation strategy will require an additional set of
complex decision-making, as well as board approvals.

Creation of a comprehensive employee benefits program

Just as with compensation programs, HR will likely be required to link disparate

employee benefits into a program that fits the newly formed organization, or simply
discard the existing plans and start over. Either way, the creation of a comprehensive
employee benefits program is a complex undertaking, and one that takes time.
Throughout that process, however, employees are sure to be concerned about possible
changes to their employee benefits coverage and will want to be informed about "the
new package" as soon as that information is available.

Communications

Having a well-planned communication strategy in place is critical in the M&A process.

Effective communication involves providing information on a) the shared vision for the
new company, b) the nature and progress of the integration and the anticipated
benefits, and c) the outcomes and rough timelines for future decisions. Communicating
clear, consistent and up-to-date information not only will give employees a sense of
control by keeping them informed, but it also can increase the coping abilities of
employees and minimize the impact of the integration on performance.

The following steps highlight the components of a successful communication program:

 Establish multiple routes of communication (e.g., one-on-one meetings, group

sessions, newsletters, intranet updates).
 Focus on the themes of change and progress by highlighting projects that are
going well and action items that are being delivered on time.
 Repeat the common themes of the M&A to increase employee understanding of
the rationale behind the transaction.
 Provide opportunities for employee involvement and feedback.
 Ensure that employees understand there will be problems, but give a
commitment that the problems will be identified and addressed as early as
possible.

Critical to successful integration is the manner in which the restructuring is

implemented. The highest priority is that the acquiring company needs to be
straightforward about what is happening and what is planned. Even when the news is
bad, the one thing employees of newly acquired companies appreciate most is the
truth. That includes being able to say "we don't know" about certain areas or "we have
not yet decided" about others. Being honest also includes sharing information about
when and by what process a decision is expected to be reached. 
 The truth also means acknowledging some of the stress and other emotions that are
undeniably present. Organizations should never tell employees that everything will be
"business as usual." The reality is, change is occurring. Likewise, employers should
resist the urge to tell employees that they have "a wonderful future" to look forward to,
when they are still confused and grieving over the past. Employers should not attempt
to sugar-coat matters with false platitudes such as calling the deal a "merger of equals"
when one company is clearly the majority stakeholder and therefore has the ability to
cast the deciding vote in a split decision.

Once decisions are made about functions and people, the organization must treat those
employees who will be negatively affected by the transaction with dignity, respect and
support. Not only is this approach the humane thing to do, but it also is a powerful way
of showing those who remain what kind of company they are now working for and of
helping them begin to develop some positive feelings toward the new organization.

The Importance of Cultural Fit

Cultural compatibility issues often arise when bringing together two or more cultures in
the M&A process. Because culture encompasses the beliefs and assumptions shared
by members of an organization and influences all areas of group life, the M&A
integration always has a degree of misalignment, regardless of the perceived similarity
between the two firms. Since cultural clashes can affect important M&A outcomes,
focusing on cultural alignment has been identified as the top challenge in M&A
transactions.

Technology and Outsourcing Decisions

Managing HR technology and deciding which systems to keep or replace, as well as

which functions to outsource, can be a highly complex undertaking. Making such
decisions requires that employers thoroughly assess the HR systems and people
capabilities of both organizations. Technology integration must occur thoroughly and
quickly enough that normal operations never appear disturbed to users.

Global Issues

Much of the pressure to compete and perform has intensified from globalization and the
emergence of China and India as two of the fastest-growing economies in the world.
During the 1990s and through about 2005, M&A activity was controlled largely by U.S.
and European-based corporations. The climate has changed as Asian-based
businesses look to expand their markets and become truly global players. The Middle
East, even with its volatile political and religious climate, also is becoming a hotbed for
M&A activity. Countries such as the United Arab Emirates and Saudi Arabia have plenty
of cash available from their vast oil wealth and are looking to diversify their business
holdings. The cultural and communication issues involved in a global transaction can
create even more complexity for HR practitioners.