Human capital M&A unprecedentedly busy

COVID-19, and the government and business response to it, has accelerated how technology and automation is reshaping the world of work. As all deal-makers will attest, disruption creates opportunities and that applies now in the ‘human capital’ sector, which covers not just recruitment consultancies and headhunters, but also training companies, well-being providers and diversity and inclusion specialists.

If human capital is something of a soulless phrase (an economist’s term, reducing people to balance sheet assets), it disguises what the sector is increasingly concerned with. Human capital not only aims to provide the best-suited personnel for companies, but also to ensure these employees are in the best position to develop and contribute happily to the performance of those companies.

In addition, some industrial sectors in the UK are experiencing skills shortages because of Brexit and there is a huge demand for expert help to address those issues. That demand is then fuelling growth in the young ventures with the relevant expertise. This is leading to a private equity feeding frenzy that seeks to both ride on and add to that growth and expansion, when established companies look to diversify the sectors and geographies they serve.

New focus

Keely Woodley leads Grant Thornton’s corporate finance team in the UK. Much of her experience lies in human capital M&A. She says after deal-making had stayed in a ‘holding pattern’ through Brexit, followed by a strong first quarter of 2020, the pandemic saw a rapid and significant slowdown. 

“The majority of human capital transactions we were working on just stopped in their tracks because nobody was hiring. We saw hiring freezes globally and a sense of panic ensued, and an understandable knee-jerk reaction to the circumstances,” she says.

There was also a pause for thought because people wanted to preserve cash. Then, in the later stages of the first wave of the pandemic, “there was a realisation that companies need to do things differently from a people and talent perspective”.

But the sector has bounced back. According to statistics published by Refinitiv, the first 10 months of 2021 have seen the highest value of deals for the past seven years – with $19.8bn completed globally.

“Well-being and mental health came into really sharp focus,” explains Woodley, “and that caused a lot of companies to re-evaluate what skills they needed within their organisations to stay relevant in the future. Also, because there was a fundamental shift to different ways of working, the skills that organisations needed to keep their own businesses running, and also to stay relevant to their clients in the field, saw surges in requirements for talent in certain sectors.”

Waiting list

James Fieldhouse, an M&A director at BDO who specialises in the recruitment sector, sees “technology, life sciences and anything associated with STEM [science, technology, engineering and maths]” as being the recruitment fields that will experience increased demand, with the former being driven in part by the shift towards digital transformation. BDO’s report about the human capital sector in early 2021 predicted deal activity would be fairly flat over the coming year, but Fieldhouse admits: “As ever, being an accountant, I was probably overly prudent. We had just seen a release of pent-up deal activity and entered another extended lockdown – I think the words I used were ‘cautious optimism’, which turned out to be overly cautious!”

Now, he sees pent-up demand coming out of the pandemic, where “companies that have probably been sitting on a bit of cash, some of which they stored up during COVID-19, are emerging thinking they’ve traded pretty well and aren’t generating much return on cash on their balance sheets, so they might as well seize the opportunity to use it.” 

Private equity dry powder is also driving the dynamic, with Fieldhouse citing greater deal activity up to September 2021 than in the whole of 2019, which was itself “a pretty buoyant year”.

Putting his cautious hat back on, however, he warns the market could have become overheated. “I’m trying to get due diligence providers on a deal currently, but people are stacked up for six weeks. It’s hard to know whether that’s a continuing environment, or a Brexit or COVID-19 bounce.”

Of the deals in motion, Fieldhouse says: “Pure consolidation has probably been the mainstay, with PLC recruiters and the private equity-backed recruitment platform businesses wanting to grow and get scale, accessing new geographies or new sectors. But with private equity raising bigger and bigger funds, they’re getting drawn to the best assets, which is creating a sort of feeding frenzy.”

Jonathan Wade, a transaction services partner at RSM, echoes the general sentiment: “Human capital M&A has been unprecedentedly busy.” He agrees it has been so hectic that there is effectively a waiting list “longer than it’s ever been in my working lifetime” for due diligence specialists in the sector.

And due diligence really is vital in this sector. Companies have to make difficult decisions and judgement calls, in a very competitive market, for the most valued assets. Wade sees companies that have footprints in both the UK and US markets as particularly attractive. “Last year, human capital deals were heavily impacted because there was so much business uncertainty. But now we’re past that and if you’ve demonstrated resilience and come through that with good management teams, proven business models and improved efficiencies, then there are new investments and there are great opportunities for further growth.”

Going global

Niraj Patel, head of corporate finance at Saffery Champness, has longstanding experience in human capital, starting with advising Empresaria Group in its AIM listing in 2005 and subsequent UK and European acquisitions. He says trade buyers are either well-funded themselves or can tap into other sources of funding, including private equity and various forms of debt financing, such as challenger banks and debt funds. “That’s making great competition for assets. Increased scale leads to higher multiples,” he adds.

Contrasts in how COVID-19 impacted various sectors means diversification has become an essential strategy for human capital businesses. Patel points out the importance of spreading risk geographically: “Cross-border has also become important, with companies expanding in the US, East Asia, the Middle East and certain European territories. You’ve got to find the people and the right partners and clearly a sensible M&A plan can accelerate that process.”

Woodley says that British companies are on the hunt. “The UK is such a sophisticated market from a recruitment perspective, we’re getting people who want to spread their brand values and go and start offices in Germany or the US. Those two markets specifically are very attractive for acquisitions, both for their vast geographies and because they’re less sophisticated and enjoy higher fee rates.”

Part of the general activity Woodley has seen has been recruitment companies buying other companies “to gain access to different industry verticals”, but she’s also witnessed PE become hungrier for deals. “Probably for the next two years at least, we’re going to have skill shortages – really quite acute ones – and so, from a private equity perspective, if I invest in a company that’s doing well in this sector now, I’m going to benefit from that natural surge in the market, in addition to whatever the company might be doing right.

“Private equity wants access to a fast-growth market and, ideally, a fast-growing specialist recruitment company that’s following a sector where all the underlying dynamics are really strong.”

Note of caution

A skills shortage resulting from Brexit, combined with the tech-led arrival of the ‘jobs-you-don’t-know-exist-yet thinking’, will change the market long term, says Wade. Some jobs will become obsolete and the need for retraining will be intensified. “Companies will come up in that space that are going to take advantage of that dynamic.”

According to Patel: “High vacancy levels currently being seen in the market would normally create obvious benefits for recruitment businesses, but actually the key challenge facing the UK market is a skills shortage and therefore labour supply. There’s increased demand, but the challenge would be which recruitment firms have the best access to supply, in which specific sectors and jurisdictions.”

And there is a big consequence. Woodley warns: “Pricing is very high at the moment. If the economy does suffer a downturn, talent solution businesses are very exposed – with reduced training budgets and potential hiring freezes. If a lot of private equity firms are going into these companies and paying high prices that means a lot of bank debt if a less prudent approach is taken.”

There is potential then for corporate challenges or even failure because structures designed to fund acquisitions are not sustainable if the company performs less well. “Our job is to try to ensure people invest responsibly and don’t over-leverage hyper-cyclical companies,” she says.