The perception of risk and value in due diligence have changed, says Laura Kellers Queen, Chief People Officer at SolomonEdwardsGroup, as more attention is paid to the people in a deal.

"Specifically, focusing on things like the human capital aspects of the business — not just the HR operations component, but also issues around succession, leadership capability, particularly post-acquisition leadership capability, in a new environment," Queen said at last year's Philadelphia Smart Business Dealmakers Conference. "Are the historical leaders, are the original founders of a business, capable of leading an organization in its next iteration?"

She says she's also seen a greater focus on diligence being the precursor to the value creation capability. It's looking for that which is not only helping to inform the financial aspects of deal making, but also understanding what can be learned in the diligence or assessment portion of a process that accelerates the value creation component of the 100-day plan on a post-acquisition basis.

While it's easy to say COVID brought social or human capital issues to the forefront, Queen says it's bigger than that.

"There were a number of things over the last three or four years that have really changed the environment from a transaction space and from a view around things like both the investment thesis and the growth thesis for organizations," she says. "One of those changes is that our marketplace, just from a macro level, has really shifted. The S&P 500 market value is largely made up of intangible assets at this point. In 1975, that's not the case. Ninety percent of market value right now is intangibles. Most of those intangibles are created through some aspect of human capital in your business; it's trade, the relationship that you have in the marketplace with your clients, the quality of client relationships, creativity, innovation that lives inside your organization. All of those things are created on the on the backs or through the value or cranial capacity of the individuals in your work environment."

COVID and recent social unrest brought to the forefront issues such as psychological and physical safety in the work environment, putting a spotlight on the way employees are treated. Then the knock-on effect of the great resignation highlighted the issues that are endemic inside organizations around how people are valued and treated, and their role in the value creation engine not just for organizations, but also for the economy, including the communities or social groups they are a part of.

Because of this trend, she says the underwriting and closing process can be smoothed significantly if the seller conducts pre-diligence on themselves, something that is aided by a good adviser. There are many things within a business, particularly at the low end of the marketplace, that are not professionalized, often because it's not necessary for them to be professionalized, however they are nonetheless asked for as part of both the diligence and the underwriting process.

"So, making sure that you're attending to things like whether or not you're meeting your EEO regulatory compliance requirements, are you capturing the analytic information you need to be able to produce effective reporting? If you have particular issues related to things like outstanding litigation, employment-based litigation, how have you handled it? How have you documented it? And thinking through that very clearly, well in advance of the diligence and the underwriting process is really critical."

She says taking those steps moves this aspect of a deal into the value creation space. For organization in which value is created on the efforts of human capital — consumer-based organizations, service-based businesses — understanding the culture of the organization, and what makes that culture work or not work is key. It's also important, then, to understand how that culture is being reinforced and what is the role of leadership in creating and reinforcing the espoused culture of an organization.

"Those are all the wraparound things that help make both attraction and retention of talent much more tenable for an organization," Queen says. "To the extent that there's a gap in the espoused values, or mission and vision, of an organization in the employee experience of that organization, you have depleted value. So, those are things that are really important to consider as you're thinking through, even in a pre-sale process, what is the story we're going to tell? How is it contributing to the value and the valuation of our business? And if remediation needs to be taken into consideration, what steps do we put in place to make sure that that remediation can happen as quickly as possible?"

She says in the deals that she's looked at, very often there is an insistence by the buyer to understand aspects such as employee engagement scores and the organization's succession plan. That could mean doing an assessment starting with the leadership at the top and sometimes all the way down to the management level to try and understand the team dynamic.

"Those individuals represent the future of the organization and buyers want to understand what is the level of flexibility, capability of that leadership team," she says. "Markets and circumstances require a lot of flexibility to be able to pivot when circumstances change. Can these teams withstand and uphold the principles of the investment thesis as they're moving forward in their growth trajectory? And we've seen deals tank on this issue — the issue of succession, particularly from a seller's viewpoint into the marketplace. If a buyer, particularly if an investor, is looking at a deal, and they don't have confidence that the business development, the client leadership and the primary delivery of that business is being well handled, and that relationship is being translated, the capability is being translated, down into the organization, but they're hearing from a seller, 'I want out in six months,' or, 'I want out immediately upon the deal,' it will reduce valuation at a minimum. But we've also seen they get pretty far down the path and then it's belly up on the deal because they just don't have confidence, an investor doesn't have confidence, that there's any business continuity."