• The current labour market and four lessons for due diligence

The current labour market and four lessons for due diligence

02 March 2022

Original content provided by our colleague Richard Crisp in BDO UK.

The post-Brexit exodus of European workers from the UK and ‘The Great Resignation’ have put enormous strain on the labour market. Many businesses are struggling as their business models and cost bases come under pressure. Below, we highlight four areas of due diligence that can help build confidence in the success of an acquisition.

When buying a company, understanding whether the target has priced in cost pressures appropriately will be crucial to being confident in your investment decision. The first step in understanding a target’s future probability has traditionally been to analyse historical trends.

However, the volatile labour market dynamics mean historical trading may not fully reflect some of the recent and continuing cost pressures.  You should consider in more detail how the current unique labour market dynamic is impacting target businesses and how you should account for this in your due diligence.

Wage inflation

Employers are forced to offer lucrative packages to attract and retain talent in competitive markets which is leading to exceptional increases in wages and salaries. Historically, an assumption of 2%-3% annual salary increases was relatively standard. Perhaps challenging whether that will be sufficient to maintain quality staff in the current environment is appropriate.

Comparing the salaries for recent hires to historical hires for the same role may give an indication of wage inflation, while increasing churn or difficulty in filling roles may indicate that current salaries aren’t sufficiently competitive.

Use of subcontractors

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 what a ‘normal’ level of subcontractor use for your target is. This will form an important part of due diligence as will the tax risks associated with off payroll labour.

Talent and growth

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

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. This will likely be cheaper in the short-term. However, junior staff will take longer to get up to speed and this can lead to a slower ramp to optimum revenue generation and profitability. Ensure you understand the hiring strategy and that it is appropriately reflected in the forecasts.

And the rest…

In addition to the labour market issues we have just reviewed, there may be further issues affecting you acquisition target. The imminent cost increases such as the National Living Wage and NIC rises scheduled for April 2022 have the potential to materially impact a business’s gross and EBITDA margins. Soaring energy prices and Brexit-related import and export difficulties are also affecting a number of sectors. Understanding these will all be critical to forming a robust view of your target’s future maintainable earnings.

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

Contact Geoff Riddell or a member of our local Business Advisory team if you have any queries.