Labour Codes and Deal Dynamics: Rethinking Valuation, Earn-Outs and Integration
The New Labour Codes have significantly altered the composition of “wages” and expanded the base for computing statutory benefits
The Indian employment law landscape has historically been characterized by a vast and fragmented set of central and state enactments governing wages, social security, industrial relations, and working conditions. With overlapping definitions, multiple compliance requirements, and sector-specific variations, the regime often created interpretational challenges and administrative complexity for businesses, particularly those operating across jurisdictions. This multiplicity made compliance not only resource-intensive but also inconsistent in application, prompting long-standing calls for rationalization.
The Second National Commission on Labour in 2002 submitted a report recommending the consolidation of central labour laws. Based on this recommendation, and nearly two decades later, the Parliament enacted four laws, namely, Code on Wages, 2019; Code on Social Security, 2020; Code on Occupational Safety, Health, and Working Conditions, 2020; and Code on Industrial Relations, 2020 (“New Labour Codes”) in 2019 and 2020. They were only notified for implementation on 21 November 2025, i.e., after more than 5 years since enactment.
The New Labour Codes have significantly altered the composition of “wages” and expanded the base for computing statutory benefits. Traditionally, in percentage terms, wages were structured between 35%-40% of the total remuneration, while under the new regime, the base is now increased to at least 50% of the total remuneration.
This change in the definition of wage, in turn, increases employer contributions towards the provident fund1, gratuity, and other social security obligations, which are calculated on the wages drawn, directly impacting the cost assumptions underlying an acquisition. Listed entities have already reflected the impact on their balance sheets during the Q3 results for the financial year 2025-26 and will do so for Q4 results as well. For unlisted entities, this could have an impact while finalising the financial statements for the financial year 2025-26.
Where redundancies are planned as part of post-acquisition integration efforts, there will be an immediate cash flow impact due to the increased gratuity and redundancy payments, like retrenchment compensation, which are calculated on wages. If the valuation at the time of acquisition is arrived at considering the cash outflows due to such planned redundancies, those calculations under the old regime may have to be revisited.
Where the payments are agreed in tranches, sellers might seek to adjust the increased cash outflows due to the New Labour Codes. Indian exchange control regulations permit a tranche-based payment for up to 18 months. So even those that were executed at the beginning of 2025, with a final tranche in 18 months, could see an impact due to the New Labour Codes. Audited financials for 2025-26 will reflect the impact which buyers may seek to rely on for adjustments. Even in a phased acquisition, buyers may want to consider the impact on the valuation for subsequent tranches of acquisition.
In earn-out models for founders, the payments are typically linked to the health of the balance sheet and EBITDA. The founders could see reduced payments due to the adjustments on account of the implementation of the New Labour Codes. Founders may perceive this as a dilution of agreed value, despite the underlying cause being regulatory. In the absence of clear contractual provisions addressing such adjustments, this can become a source of dispute between investors and the founders.
Beyond financial modelling and valuation, the New Labour Codes introduce important compliance and governance considerations for the new management
Beyond financial modelling and valuation, the New Labour Codes introduce important compliance and governance considerations for the new management. A significant shift arises from the restriction on the engagement of contract labour in core activities. While the intent is to curb long-term dependence on contract labour for perennial functions, the provision creates a material risk for acquirers in workforce planning. In cases where the target has historically relied on contract labour for core operations, the new framework may compel the new management to either regularise such personnel or restructure operations to remain compliant. This can lead to an unanticipated expansion of the on-roll workforce, with corresponding increases in fixed employee costs, statutory contributions, and long-term liabilities. In an M&A context, this not only affects post-acquisition integration strategy but may also require reassessment of headcount assumptions, vendor arrangements, and overall cost projections embedded in the transaction model.
Similarly, the industrial relations landscape has undergone a shift. In establishments with multiple trade unions, the earlier practice of engaging with a dominant union, even in the absence of formal recognition requirements, is being replaced by a more structured framework. Where no single trade union commands a majority, the formation of a negotiating council becomes necessary. This introduces a formalised mechanism for collective bargaining, requiring new management to engage with a broader representative structure rather than relying on informal or bilateral arrangements.
These compliance changes intersect directly with post-acquisition integration. New management teams, while seeking to align compensation structures and policies with the statutory framework, may face resistance from employees who perceive these changes as cost-cutting measures rather than compliance-driven adjustments. Comparison with prior management practices can intensify this perception, particularly where legacy benefits or procedural frameworks are altered. This, in turn, can affect employee morale, increase attrition risk, and slow down integration into new operational processes.
In this context, workforce integration must be approached as a combined legal, financial, and organisational exercise. The New Labour Codes have reduced flexibility in wage structuring, increased statutory cost visibility, and introduced new compliance frameworks that directly impact management discretion.
At the same time, successful integration will depend on how these changes are implemented on the ground. Transparent communication, phased alignment of compensation structures, and careful handling of employee expectations can mitigate resistance. Without such calibration, even legally compliant actions may be viewed with skepticism, undermining the broader objectives of the acquisition. As a result, business could be impacted and having a ripple effect in valuation, impacting the exit for investors at a later stage.
Disclaimer – The views expressed in this article are the personal views of the authors and are purely informative in nature