Greg Bedrosian of Drake Star Partners joins The HR Risk Podcast to discuss emerging HR due diligence trends in M&A transactions. Interested in how Ekdesk’s Sonar analytics can help identify #MeToo and similar issues in M&A transactions? Learn more about Sonar here or reach out to us at Subscribe to The HR Risk Podcast on iTunes/Apple Podcasts, Stitcher, or your favorite podcast app!

Jennings: Our topic today is HR Issues in M&A Diligence. For many companies–from large public firms to fledgling startups–being acquired is part of a long-term exit strategy. Or, sometimes, M&A emerges as an unplanned opportunity to realize significant value for shareholders and other stakeholders. In any case, before a deal can close, every M&A transaction will involve a buyer looking thoroughly under the hood for potential issues. This is called the due diligence process. Traditionally, major areas of concern have included financial results, customer contracts, major litigation, and even specific issues like environmental liability. But in the last year as the #MeToo movement continues to raise awareness of workplace harassment, employment issues have also gained attention during the due diligence process. Joining us today to discuss how employment issues, including #MeToo, are affecting M&A deals is Greg Bedrosian. Greg is co-founder and CEO of investment bank Drake Star Partners. Greg’s investment banking career has spanned over 25 years of advising leading technology, media, and telecom companies on mergers & acquisitions and private equity transactions. Throughout his career, Greg has lived and worked across the U.S., Europe, and emerging markets, so he brings expertise in cross-border as well as domestic M&A.

Jennings: Greg, welcome to The HR Risk Podcast.

Bedrosian: Thank you. It’s great to be a part of it.

Jennings: Before we get into how employment issues are affecting the M&A process today, I wondered if you could give our listeners just a really high-level overview of what is the due diligence process, what are buyers looking for, and how can that affect whether a deal gets done and at what price? And maybe part of that is what role do escrows play? What are escrows, first of all, and maybe whether this varies depending on whether it’s a publicly traded company that’s being sold, or whether it’s a private company?

Bedrosian: Sure. Great set of questions. By way of background, as co-founder and CEO of Drake Star Partners, we are a firm focused on advising companies on mergers and acquisitions, predominantly in the technology, media, and telecom sectors. Although my career before that has included a broader set of sectors, most of my 25-plus year career has been involved in those fast growing sectors. And I can draw from some of those experiences. Typically when a company enters a due diligence process–and due diligence is just a fancy name for question and answer and seeking discovery of what’s really going on at the business–typically there would have been an initial indication of interest to acquire the business, but that would have been what’s called “subject to due diligence.”

Bedrosian: And that due diligence can involve investment banking advisers like our firm, legal advisors, accountants and others, all really helping the potential acquirer dig in and understand various parts of the target company. And that really is often financial information. It’s legal topics and a lot of it is HR and employment topics. So to address your question around how that plays in and how it impacts things along the lines of escrow, a couple of elements. Normally the due diligence phase will last anywhere between 30 and 60 days. And at the end of that, a set of findings is discovered. And normally a buyerbecause no company is perfect– has found a few sets of surprises or question marks along the way. They may be in the financial review; they may be on the legal side; they may be on the HR or employment side. Typically what the buyer and seller will do to bridge a gap is agree to what’s called an escrow, which is putting away a modest percentage of the purchase price and holding that back to protect the buyer in case some uncertainties happen, usually over the first one or two years after an acquisition is done.

Jennings: Is that typically something that’s going to vary between a public company or a private company?

Bedrosian: Good question. The escrow concept is more typically found in private company M&A. The reason being that in a public company environment, there’s by nature much more disclosure on the financial, legal, and business fronts. And oftentimes mergers and acquisitions of public companies are done on what’s called an “as-is” basis. So you’re receiving the information and you’re meant to decide what price and what terms you’d like to complete the deal. On the private company side–which in the M&A landscape across the U.S. and worldwide, the vast majority of M&A is of private companies–of course those are where the escrow will come into play and it’s very common practice for buyer and seller to have an escrow in it for a private company merger.

Jennings: Thank you for that. I think that sets the table nicely on the overall topic. I wonder if we could zoom in a little bit on the HR aspect of that due diligence process. What issues in the HR world have typically been looked at or addressed in the due diligence process, or maybe not looked at as much, and have you noticed any changes in focus areas or what types of HR issues that buyers are looking for? And is it something that’s being driven by certain companies or certain industries or is it across the board changes that you’re seeing?

Bedrosian: Right, so there are, I would characterize employment topics into two broad camps and we can unpack the topic further, because I know that’s a core of what we’re going to discuss today. On the one hand employment topics come up around ensuring that great talent is kept and maintained and flourishes within the deal, post-acquisition. The other end of the spectrum is to avoid liabilities that are tied to employment issues. And so again, speaking especially within the tech, media, and telecom sectors, they tend to be more defined by, more founder-centric and founding team. In more entreprenurial environments, where if a big corporate is actually looking to acquire them, part of it is for the business, but actually part of it is for that team. And so in those situations, oftentimes there’s diligence around employment agreements and ownership stakes of those key core founding members. And there’s quite a lot of thought that will go into creating the right incentives package to help ensure that post-acquisition when those more entrepreneurial founder types are part of a larger successful corporate: they’re motivated, excited, and adding value to the combined business.

Bedrosian: Because again, that’s often one of the core reasons why the transaction came to the fore. The flip side, of course, is to look and ensure that employment and HR topics aren’t creating liabilities, known or unknown, that may end up creating issues–legal, financial and otherwise–into the business. And it’s that latter part that I think certainly in the context of the #MeToo environment–in Wall Street, it’s sometimes called the “Weinstein” clause in M&A transactions–where there’ll be deeper focus on understanding and digging in and having the seller make certain representations and warranties around employment issues, particularly around social elements of the employment arena, that will help protect prospective buyers.

Jennings: I think that second part about reps and warranties around the social element is really interesting. It’s an area that seems to be shifting a little bit because traditionally, materiality is the watchword for the due diligence process and that’s usually meant “have we found an issue that is financially, or quantitatively, material to the transaction?” And in the case of a #MeToo issue or an employment discrimination issue, it may be that a claim is worth a few hundred thousand dollars if a judgment is obtained against the company–which is a lot of money, but in the context of a billion dollar, or multi-hundred million dollar, deal, isn’t necessarily material financially. But the facts behind the claim might be pretty damaging, particularly if they involve allegations against a founder or senior leadership, because that’s a big source of value, particularly for a private company acquisition. Have you seen any greater emphasis on qualitatively material due diligence issues around HR? How are companies, or how are buyers, assessing what is qualitatively material? That’s a little bit of a harder cutoff versus “$1 million is what we consider material,” or “$100,000 is what we don’t consider material.”

Bedrosian: Correct. It’s a great question, and it’s an evolving process that we’re seeing as investment bankers in the merger and acquisitions landscape. Again, I’ll emphasize it’s not exclusively, but currently, more actively discussed in transactions within the entertainment, media, and tech sectors. They tend to be more founder-centric businesses. They also tend to be businesses where materiality is harder to identify there. There’ve been some situations–just to lay the context of some examples where a legal claim through an HR department might only theoretically be in the hundreds of thousands of dollars–but what ends up happening is the prospective buyer will then bring up, “well, you know, that could have a knock-on effect.”

Bedrosian: Reputationally, we saw what happened with The Weinstein Company; that’s why it’s often used in quotes as the “Weinstein” clause. A media company worth hundreds of millions of dollars literally evaporates on the back of various allegations that are, by the way, still pending throughout the process. But in the meantime, the entertainment community and the financial investor community moved away from that business in such a way that it’s not sustainable anymore. So there’s an element where qualitatively, if the allegations–and again they could be allegations without a definitive outcome at the time of the pending acquisition–when you’re in that situation, the buyers are always thinking through, “do I want this allegation on the front page of social media or traditional media that our company is affiliated with these issues,” through to “would my clients, customers, and employees be concerned about working at a company if this was something that was going on?” So in a way, something small financially, but impactful in terms of the allegation, really has a disproportionate effect, versus a financial question in the audited accounts or something where it’s clear that one could limit the exposure to a set dollar amount.

Jennings: Where are buyers drawing the line in terms of “these allegations aren’t immediately material financially?” That is, they don’t directly relate to a legal claim that might be at a material threshold: it’s not a $1 million claim, $5 million claim, that sort of thing. How are they drawing the line right now in terms of what they want to know about? Are they dividing it out by “we just want to know about allegations against senior people,” or “we want to know about all allegations, a full airing,” or is there a mixed approach to that?

Bedrosian: Well certainly that’s on a case-by-case basis, but oftentimes the disproportionate focus is on the senior talent and then personally, which we’ve seen, rep’ing or warrantying about no bad behavior, no allegations will emerge, etc., which is quite a strong stance to take by a prospective buyer. And I think in the absence of the #MeToo movement and in the absence of what literally happened to The Weinstein Company and the coining of the phrase, “the Weinstein clause,” some of those types of questions historically would have been viewed as overreaching or more personal comments that may or may not be tied to business. In this case we are seeing on a case-by-case basis–and I want the listeners to understand this isn’t the majority of the transactions but it’s a meaningful percentage–again, especially in some of these sectors where these reps and warranties are being requested, the reasons are some of the points that you highlighted. I think another interesting question is how does one remedy or address that? Because in a way these are very open-ended questions that once lawyers try to put those into transaction documents, things can get complicated.

Jennings: With this new emphasis on, or this new approach, to diligence for these issues, are you seeing that they’re having any after-the-fact real effect on deal structures or terms?

Bedrosian: The predominant way that–in the transactions that we’ve been directly involved in and those that I’m aware of in the market–the predominant way that there’s been the impact has actually been the escrow topic. Typically, as an example, an escrow, if it was a hundred million dollar M&A deal or a billion dollar M&A deal with a private company, it would often be plus-or-minus a 10% hold back in an escrow. So $10 million on a $100 million deal, and so it goes. Oftentimes what we’re seeing is to solve the issue, buyers and sellers are agreeing to a slightly higher escrow. Maybe that’s 15%. We’ve actually even seen in certain cases 20%. The reason why that’s a palatable solve is in the scenario where the sellers’ representations are accurate and nothing happens after 12 or 18 or 24 months, however long that escrow lasts, the seller is still getting full value for the full purchase price for the company. It’s just being held back to wait and see and make sure. And so that to date has been the way that buyer and seller can bridge that. What it does mean is, of course, the shareholders of the selling entity are getting a little bit less of the deal value up front and they’re having to wait a little bit longer to get the full value. But that tends to be the compromise that we’re seeing in some of these transactions of late.

Jennings: I don’t know if you’ve seen this, but in a way it could be a bit of a tell if management really balks at a higher escrow amount for these types of issues, might be a little bit of a tell that they have some concerns.

Bedrosian: I think more and more it’s entering the mainstream of the diligence discussion, and hence the negotiating deal points, in a similar way to the review of financial audits and quality of earnings and requesting pending customers, pending revenue events, pending contracts. Per your point, the more the seller balks at some of those reps or warranties on the financial side, the more nervous the buyer may get. Similarly, on the social- and employment- and HR-related topics, the more they balk, it could potentially raise a red flag in the minds of the buyer. And that’s why my sense is, and again, there’s been a relatively few number of data points to date. But it’s a growing number with that sort of escrow increasing to maybe 10 to 15 or 20%. In situations where that topic is relevant, it’s more and more the norm. And at least the seller in that scenario understands that they’re still getting the vast majority of the proceeds at close and there’s a calculated, reasonable sum that’s being held back to protect against these possible scenarios.

Jennings: You alluded a few minutes ago to the different approaches that people are taking to the diligence process and with the “Weinstein” clause–there’s not necessarily one “Weinstein clause,” a variation in practices–but what are you seeing in terms of how buyers are trying to define the issue and what different approaches are lawyers advising them to do? I don’t know if it’s driven by the legal side or by the buyer itself?

Bedrosian: Right. Well, I think it’s partly on the negotiating side and it’s partly also how beyond the escrow structure, the problem is solved financially. I think first of all, these “Weinstein” clause-related topics are brought up earlier in the discussions. Secondly, the escrow element is put on the table usually earlier in the process. But thirdly, and quite interestingly, there’s an element of insurance called rep and warranty insurance. For those of your listeners who may not be as familiar with that concept, it’s basically insurance companies that, like one would insure a home or a car, they’ll actually come in for a price, for a premium, and insure the outcome of the representations and warranties. So in my earlier example, let’s say there’s $10 million held back of a $100 million transaction. An insurance company could come in and say, “I’ll for a cost of $500,000 or a million dollars,” depending on how they evaluate the risk, “you, Mr. Seller, will pay me that 500,000 or a million and I’ll absorb any exposure up to that $10 million sum for what may happen with the representations and warranties.”

Bedrosian: So in that example, if it’s a $100 million deal, rather than the sellers getting $90 million and waiting for the other $10 million to get to a hundred, they’re actually getting $99 million. If they paid a million now, they’ll never get that premium back for the insurance. But they’re getting $99 million up front at close, and they’re willing to take that slight discount for certainty. What we haven’t yet seen, and I think this is an opportunity both for companies as well as some technology platforms and others, we haven’t seen enough of an infrastructure within companies to record complaints issues on a confidential basis in whatever format so that an insurance company can analyze some of that data and get comfortable to underwrite a rep and warranty policy.

Bedrosian: For example, in financial or legal diligence, the insurance company will send people in to review the documents in a similar way the buyer would, and then judge risk. The issue today is with #MeToo-related clauses and other elements across the employment spectrum that haven’t been tracked, or the confidential nature makes it harder to track. There are fewer data points for an insurer to evaluate. So one of the trends that we see, but it’s only the very beginning, is a rise in monitoring–evaluating and storing through technology platforms or otherwise–some of these complaints, issues, topics around the #MeToo-related and other clauses so that insurers can better understand it, but also buyers can better understand it. And I think that really moves things from opacity, from one person’s word against the other, to something that is easier to monitor. And to be clear, we’re at the early stages of that becoming commonplace within companies. Certainly small companies that have more limited budgets in terms of buying technology platforms aren’t subscribing to them. But that’s an interesting trend that we see and predict really evolving to address some of those needs between buyer and seller.

Jennings: That’s interesting, because in the diligence process you have this financial data–which is inherently quantitative–you’ve got data about customers and the market and that sort of thing, but this is something that is more opaque. And it might be opaque because maybe even the company doesn’t know what issues it has, because it hasn’t been told by people that they have issues. And so there might be room for technology to address that. In terms of going forward, you’re talking about the early stages of this issue becoming more prominent in M&A transactions. Where do you see us headed in 2019? Do you see us getting to a point in the next two years where this is just a standard issue in every M&A deal, that it has to be part of the diligence process? Or is it going to be more of a case-by-case basis based on the type of company, the type of industry, the founding team, that sort of thing?

Bedrosian: It’s a great question, and if I were to try to predict 2019 and maybe even into 2020, elements like this tend to have an inflection point where, early on, we’ll see it in a handful of transactions and a handful of investment banking advisors and M&A lawyers will be aware of it and bring it to the fore, and then it will start to hit an inflection point where it becomes more common than not. I would estimate right now that it’s certainly the minority of transactions where that’s a core part of the due diligence. If I were to estimate–just an estimate–I would say it’s probably in 20-to-25% of transactions, probably a higher percentage within certain industries. Again, like in the entertainment and the technology sectors, I think it’s more front of mind and it’s more than 20-to-25% of transactions. But if I were to expand that across all industries, that would be my estimate. I don’t believe in 2019–possibly by 2020–there’ll be that tipping point where the majority of transactions have one or more of those elements more standard as part of the diligence process. But I see it coming. And that’s quick in the M&A world, something that’s broadly adopted in a several year period is actually rapid adoption. M&A has been around for a few hundred years. And so something that can become relevant and evident in the majority of deals–as I’m suggesting, and maybe by say 2020–it would be quite rapid adoption.

Jennings: I think that makes a lot of sense. And there’s an element with M&A agreements where they’re often a template that law firms will use and they’ll adapt for every transaction. But sometimes when a standard clause gets in, it just holds on pretty quickly. I remember in a past life when I was practicing M&A law, there is an asbestos disclosure clause that’s in a lot of agreements and it’s fairly standard. But I was working on a transaction for a company that just had no, just the nature of this business was that there would be no asbestos involved in anything that they did. But we still had to do that diligence and make sure that that was satisfied. Greg, if listeners want to learn more about you or Drake Star Partners, where can they go to find that information?

Bedrosian: We’re most reachable via our website, which is, and we would welcome outreach and inquiry. It was a real pleasure having this conversation with you today.

Jennings: Great, I’ll put a link to that on the show notes for the episode. Our guest today has been Greg Bedrosian. Greg, thank you for joining us.

Bedrosian: Thank you. It’s been my pleasure.


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