The importance of human due diligence – Why people are a company’s most valuable asset
— This article is based on a true story ––
Back in 2010, I was the COO of a startup aimed at developing digital solutions for broadcasters. We had raised €7M in several rounds and, after a rollercoaster period, we received an acquisition offer from a British company that was listed on the London AIM Stock market (The London Alternative Investment Market, equivalent to the Nasdaq in New York). After some negotiations, we decided to move on with the operation as it seemed to have huge benefits for us. Money aside, although that was obviously a big part, the M&A was supposed to give us the power to grow and expand internationally.
What still fascinates me years later is that the process was both extremely demanding… and incomplete.
A quick look at the IPO process
Now let me preface this with a bit of context on IPOs. If you have ever been involved with one, you’ll know how tiresome the bureaucracy and legal protocols can be. If not, here is a brief summary of the admission process:
Once a company has made the decision to seek a quotation on AIM, the first step is to identify and appoint a Nomad , short for AIM-approved Nominated Adviser, who will help the company come to market. They will look into your business to confirm whether you meet AIM’s criteria. If you do, they will guide you through the flotation process.
Convincing a Nomad that you’re suitable for AIM is only the start. You then enter a process of due diligence. Lawyers, accountants, technological audit firms, brokers, public relations and investor relations firms will study your company to ensure there are no problems that might be a source of conflict problems for the Nomad. The scrutiny will be strict and their findings will be published in a series of reports. The company will need to prepare an admission document that includes details about its directors, financial position, business activities, and strategy.
After that, you’ll enter the application phase, during which you have to submit the official requested documents. Then, last but not least, you start the fundraising.
(*More detailed info here)
IPO + HR = ?
Back to our real case, the due diligence for our company involved more than ten firms and took almost one year. It was really hard work. I was managing the process, almost a full-time job coordinating all the advisers and providing them with the information requested together with our Ops team.
But, let’s take a closer look at one detail… Regarding the founders and the team, which information did they analyze? They just sent us an HR checklist which mainly consisted of:
- Employees’ labor contracts
- Employees’ benefits plan
- ESOP (Stock options plans)
- Formal Organizational chart
- Legal rights and duties of the employees
- The Capabilities of the Directors’ and their ability to prepare reliable budgets
After 10 months of Due Diligence, the deal was closed successfully. We did a huge celebration and increased salaries! Big applause!!
And yet… We were about to start a new era with no solid foundations in place, with no alignment nor agreement between all the employees on new behaviours and procedures.
The IPO+HR debt
As you might have guessed, problems soon arose related to:
Company Culture: There was a mismatching between our culture and the new owners’ culture, and no plan for culture fit, which made the coexistence of the two teams really difficult. It is fair to say that no one, neither the acquirers nor us, investigated deeply on the other party’s culture, values or behaviours.
Key Employees: Key employees started to leave, due to demotivation. Our specific culture had long been key in keeping people highly motivated, so when that identity changed, people started to jump out of the boat. No one targeted them beforehand to plan retention strategies for them. Nobody wondered ahead of time what would be the cost of losing one of the key engineers; how long will it take to get a replacement with the same talent level, same knowledge of the company and of the product.
Co-founders/Leaders capabilities: Running a public company is very different from managing a privately-owned business. You will have to be prepared to comply with the governance expectations of shareholders and the demands of market regulators. There are different types of entrepreneurs. Typically, the ones that are “initiators” struggle with putting processes in place and following strict rules or bureaucracy.
Co-founders conflict: The disagreements between the co-founders themselves started to be increasingly common. While they complemented each other very well in terms of skills, they had different approaches on executing the vision. And more importantly, there was a misalignment on their values.
Strategy/Vision misalignment: Conflict between founders and new owners emerged due to lack of alignment on vision, ambition, and strategy. Guess what? Yes, founders moved on…
The shift towards Human Due Diligence
This real case happened almost 10 years ago, and things have been moving in the right direction since then. Not just for M&A, but also for fundraising in general. As a matter of fact, investors and accelerators now pay a lot more attention to Human Due Diligence. As for startups, they are more conscious of the importance of building a strong culture and solid connections between teams. They also know that they have to understand who their teammates are, what motivates them and how to retain key employees.
Nowadays, big funds such as European heavyweight firm Atomico are putting a lot of effort into analyzing the human side of the business. They already have Talent Partners on board who dedicate themselves full-time to screening teams and founders before investing and helping startups grow their teams after the deal.
That’s also the case at the Tenkan-Ten Acceleration program by Asics: we work hard on understanding not only the businesses strategy, projections and growth metrics of the startups, but also on getting to know the people behind them. Who are their leaders? Which type of leaders are they? Do they have a clear and strong company culture? How do they plan to retain their key employees? Have they ever identified who they are?
We strongly believe that people should be at the center of every strategy. That a company’s culture is the most powerful resource that a business has to attract, recruit, and retain the highest level of talent.
Harvard Business School Professor and author of The Founder’s Dilemma Noam Wasserman found out in his studies that nearly two-thirds of early-stage failures stem from people problems; and that nearly two-thirds of mergers fail due to the fact that human capital was not correctly evaluated.
Human Due Diligence can help uncover capability gaps, points of friction and differences in decision-making processes. It is a data-based exercise that complements investors’ gut feeling and helps them minimize the risk of investing by anticipating potential people issues. It serves as a great incentive for startups to do what they will eventually need more than anything else: build the solid foundations that they will require as fast-growing companies.