Determining the Value of Human Capital
A trained, skilled and innovative workforce able to work as a team to achieve strategic goals is worth its weight in gold. But beyond the metaphor, how do employers determine the worth of human capital to their businesses? Is it possible for companies to measure the value of such an intangible asset? A valuation professional can provide objective market data and financial analysis to help support an accurate human capital appraisal.
What Is It?
Human capital comes in many forms. The most obvious example is employees on the company’s payroll. But it also may include relationships with independent contractors, consultants and celebrities, as well as employment contracts, noncompetes and confidentiality agreements.
Employees who hold professional licenses may be considered another type of human capital, because they allow professional services firms and other industries to conduct business and, therefore, add value. But these licenses can’t be transferred to third parties and, therefore, are typically the property of individual practitioners, not the company.
What’s the Best Approach?
A logical starting point for valuing an assembled workforce is to estimate the cost to reproduce or replace the company’s workers. This estimate includes the costs to recruit, hire and train each level of the company’s workforce. Valuators consider such items as headhunter fees; salaries and benefits of recruiting and training staff; costs of background checks, drug tests and screening exams; and relocation fees, moving costs and signing bonuses. They also look at classroom materials and fees, as well as lost productivity of new and existing staff during the recruiting and training processes.
When valuing workforce assets, a valuation makes an important distinction between reproduction and replacement cost. Reproduction cost is the current cost of an identical property — in other words, the same number of employees with the same skills, education levels, experience and salary requirements.
Replacement cost is the current cost of employing a similar workforce that has the nearest equivalent utility to the existing workforce. Replacements might be younger employees who are willing to perform the work for less money — or fewer employees who are more qualified and efficient — than the existing workforce.
In some cases, an appraiser may decide that the company is paying higher labor costs than it should. Sometimes, however, excessive labor costs arise from union agreements or family commitments and may be unavoidable.
Valuators also watch out for employees nearing retirement who may need to be replaced soon. If a significant number of key employees are nearing retirement, it could affect the value of a company’s workforce.
Does it Make Sense?
Although the cost approach is the most common way to value an assembled workforce, the income or market approaches are sometimes used to gauge whether the results of the cost approach make sense.
For example, an appraiser could divide the value of a professional practice’s workforce under the cost approach by the number of employees to calculate the average value per employee. He or she could then compare this amount to the average net realizable billable hours per employee to impute the firm’s return on human capital.
Assembled workforces aren’t normally sold as separate assets. So the market approach is rarely used to value human capital. But an appraiser might calculate the value of a workforce under the cost approach as a percentage of the company’s total value and ask: Would a buyer be willing to pay this much to acquire these assets? Or would a seller be willing to give up these assets for this amount?
What’s it Worth?
There are many circumstances — such as business combinations, divorce or shareholder disputes — in which companies might find it useful to put a number on the value of their people. The Valuation Team at MFA can provide the expertise needed to quantify this seemingly unquantifiable asset.
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