Understanding the current labour market is essential when it comes to business acquisition. Richard Crisp highlights four areas of due diligence to consider when buying a company.

The post-Brexit exodus of European workers from the UK and ‘The Great Resignation’ have put enormous strain on the labour market. Some companies are struggling as their business models and cost bases come under pressure.

When buying a company, understanding whether the target has priced in cost pressures appropriately is crucial to making the right decision. The first step in understanding a target’s future probability has traditionally been to analyse historical trends.

The volatility of the current labour market dynamic means, however, that historical trading may not fully reflect some recent cost pressures. You should further analyse how this unique labour market dynamic impacts target businesses and how it can be accounted for in your due diligence.

Here are four areas of due diligence that can help build confidence in the success of an acquisition.

1. Wage inflation

Employers are being forced to offer lucrative packages to attract and retain talent in competitive markets, leading to exceptional increases in wages and salaries.

Historically, an assumption of a two to three percent salary increase annually was relatively standard. Employers need to be aware that this may not be sufficient to maintain quality staff in the current environment, however.

Comparing the salaries for recent hires to historical hires for the same role may indicate wage inflation while increasing churn or difficulty filling positions may indicate that current salaries are not sufficiently competitive.

2. Use of subcontractors

Some businesses may be turning to subcontractors to plug gaps and overcome short-term resourcing constraints. Even when this is justified to allow flexibility around seasonal peaks and troughs, it tends to be more expensive.

You should strive to establish a ‘normal’ level of subcontractor use for your target. This will form an important part of your due diligence, as will the tax risks associated with off-payroll labour.

3. Talent and growth

The achievement of business plans is often heavily dependent on a company’s ability to grow the staff base and attract suitably experienced individuals. Consider adapting the pace of projected growth to allow some contingency in a challenging hiring environment.

4. Staff training and development

Some companies may choose to take a long-term approach and invest in developing junior staff rather than pay a premium for experienced talent. While this will likely be cheaper in the short term, junior staff will take longer to get up to speed.

This can lead to a slower ramp to optimum revenue generation and profitability. Make sure you understand the hiring strategy and that this is appropriately reflected in your forecasts.

And the rest…

In addition to labour market issues, your acquisition target may also be dealing with other challenges.

Imminent cost increases, such as the National Living Wage and NIC rises scheduled for the UK in April 2022, could materially impact a company’s gross and EBITDA margins. Soaring energy prices and Brexit-related import and export difficulties are also impacting some sectors.

Understanding these issues will be paramount to forming a complete view of your target’s future maintainable earnings.

These issues have affected our recent due diligence deals and may continue to do so for some time. It is important, therefore, that your projections model is flexible and robust enough to model scenarios and sensitivities. This will help you to avoid any nasty surprises.

Richard Crisp is Director of Corporate Finance Director at BDO UK