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Pensions matter when buying a business

By Gabe Langerak | March 22, 2022

What to look for, what to look out for, and what to agree to regarding pension plans in an acquisition.
Mergers and Acquisitions

When acquiring a business, significant risk exists within the pensions space – legally and financially – and within the HR space. Pensions encompass defined benefit (DB) pension plans, other DB liabilities* and defined contribution (DC) pension plans.

The word “pensions” has different meanings depending on the context.

The word “pensions” has different meanings depending on the context. This article refers to pensions in the broader sense, touching on accounting principles and direct costs.

Failing to look ahead at pension options during due diligence may result in complex and expensive pension solutions post-close. After all, the result of your due diligence is included in the sale and purchase agreement (SPA), and that paves the path to close and the years (often decades) following.

Based on our many years working on M&A negotiations, the following tips will help you avoid pitfalls and get your next deal right vis a vis pension plans, including identifying risks associated and moving towards implementation.

Five key learnings from our experience

  1. 01

    Identify all liabilities

    Identify all potential DB pension and other DB liabilities and make sure you understand the associated risks. Remember to look at what is reported as a DC pension plan and make sure these are accounted for properly. Missing or unreported liabilities and incorrect accounting can become very costly. For example, when you realize you’ve effectively bought a pension fund rather than a company.

  2. 02

    Map out plan structures

    Understand the plan structures and determine where decision-making lies, including possible employee consultation (e.g., employees, trustees, works councils). This will help you understand potential future risks, as well as what and when changes can be made.

  3. 03

    Understand future implications

    Negotiate based on reality. Do not immediately agree to a “nothing changes” comparability clause or communication strategy, both of which can lead to thorny problems or significant expense.

  4. 04

    Use clear language in the SPA

    Be clear and explicit about how the purchase price adjustment is calculated in the SPA and which benefits are reflected. Even actuaries using the same sets of assumptions and methodology can produce different results.

  5. 05

    Know future interdependencies

    Plan for the administration of all DB and DC pension plans – whether that is via local/regional HR or an HR hub/shared service center -- and understand the interdependencies between payroll and HR information systems (HRIS). Suppose the acquisition does not include the resources (people and systems) needed to administer the plans. In that case, you will need to prepare for the necessary structure to ensure continuation post-close, potentially via a transition service agreement (TSA).

What and where are you buying and how will the business be transferring across?

Ask yourself these three questions – and remember answering these questions as early as possible is ideal.

  • Where is the business based?

    Pension prevalence is highly dependent on the country where the business is based. When buying a business, pensions can be a significant liability, especially in countries like Germany, the United States and Japan that have many classic/legacy DB pension plans. Moreover, it is critical to know how many employees will be transferring across. This will provide insight into potential DB pension plans and other DB liabilities.

  • What is the history of the business or industry?

    The history of the business or industry will provide context for what plans likely exist. Certain industries are highly regulated across many countries, often with collective labour agreements. For example, industry-wide pension plans and DB plans are almost a given in the chemical and financial industries. The history of the business also provides context, as rich DB pension plans with corresponding liabilities are generally a legacy product. They are not likely to be provided by start-up/scale-up companies or those created in the 2000s.

  • What type of transaction is it: asset or share deal?

    The type of transaction can provide some provisional guidance on risks from an employee benefits point of view. Where an asset deal generally allows for more room for customization and searching for equitable (and potentially easier) solutions, legacy benefits are more likely to transfer with the legal entity in a share deal. Regardless, legal advice should always be sought in these types of transactions to ensure compliance with local or regional M&A laws.

Phase: Due diligence

Reviewing the information provided by the seller

Once you have gained a basic understanding of the nature of the transaction and defined some early hypotheses of where pension risks and liabilities are likely to occur, it’s time to review the data provided by the seller. Sellers are typically cautious about the information they share (especially experienced sellers). But your work in the initial assessment will allow you to quickly identify information that is missing. The most significant information is usually the data that has not been provided in the data room.

From a financial point of view, pension liabilities may have only been provided to the extent there have been actuarial valuations performed for specific plans, which has to do with materiality thresholds and agreements made with the seller’s auditor. This is particularly relevant when looking at a smaller business carve-out, where materiality to the overall company is likely not aligned with what is deemed material from the perspective of this smaller group. Critical questions at this stage include:

  • What liabilities are included and what information is missing?

    Some countries have statutory pension requirements. If there are employees in these countries, a liability must be attributed to the requirement. Examples include end of service liabilities (the Middle East), retirement indemnity plans (France), and termination indemnity plans (India, Italy and Mexico). All potential pension plan liabilities should be questioned and reviewed, recognizing that more established companies have a higher risk of sponsoring historic DB pension plans.

  • What is the risk of an underreported or changing liability?

    The likelihood of such a risk depends on the country, the type of transaction and the group of employees impacted. For example, depending on the country, liabilities may be impacted by a change in control clause triggered at close, contributions needing to be re-established, changing funding requirements, or required top-up payments. Such an impact may not be immediate but can occur post-close or years later. This goes hand-in-hand with the type of transaction and generally requires legal review to identify potential clauses triggered.

  • Trust, compliance and completeness

    Finally, what is your overall view of the information provided? Do you trust the seller has provided you the necessary information? Have they been compliant in the past? Are you confident no other liabilities will be discovered later? For example, is the information pertaining to participants and the obligations that will be expected to transfer clear? Thinking ahead and closing out any incomplete details is crucial.

After reviewing the financial information, formulate a strategy to address the post-close set-up and likely complexities. We have seen situations in which the complexity of the pension arrangements was underestimated, especially when looking at a carve-out of a business. When this happens, finding an equitable solution is difficult, if not impossible, and very costly. Understanding these elements upfront and adding the correct wording, warranties and indemnifications in the SPA can save a lot of headaches and concerns in the next few years, possibly decades.

Phase: Signing, post-merger integration

Implementation, operation and financial

Once all plans and risks are identified, you’re ready to negotiate. At this point, you should know the full breadth of your pension plans and pension liabilities. Which pension liabilities can be left behind and which can be taken on? If liabilities are taken on, what are the financial and operational implications? For example, are TSAs required and, if so, for how long?

This brings us to how pension plans are included in the SPA. Consider SPA terms not only from a financial or deal perspective but also implementation and operational perspectives.

  • The financial perspective considers the purchase price, which pensions can significantly impact. How pensions and benefits are included in the SPA is essential. For example, while jubilee and long service award plans are not reported under U.S. generally accepted accounting principles (GAAP), they would be within the scope of international financial reporting standards (IFRS). Similarly, local funding reports for Swiss cash balance plans are likely to be close to fully funded but would generally not be fully funded under IFRS or GAAP measurements. The underlying accounting or funding standard that will be used to determine the purchase price adjustment for each country should be thoroughly scrutinized.
  • The implementation and operational perspectives look at the future state of the DB and DC pension arrangements. Employee compensation and benefit comparability clauses are critical. Agreeing to something nearly impossible to implement is a genuine concern. It will most likely be impossible for the employees to remain under their current plans, and specific benefits may no longer be offered or cannot be replicated. Therefore, try to avoid terms that promise or imply that nothing is changing. If entire pension plans are included in the transaction, be sure you understand the administrative burden and have a contingency plan in place or develop a plan for future handling. Furthermore, be sure to understand the interdependencies between payroll and HRIS. If few HR business partners are transferring with the acquired organization, if you are carving out HR support from a wider group or shared service centre, if (HR) IT systems need to be established, or if the payroll structure needs to be established, make sure to carefully plan for your needs to operate post-close, potentially via a TSA.

The elements outlined here can significantly impact the purchase price of the acquisition and the future success of your business. Make sure you navigate the minefield of any transaction strategically, not only from a financial point of view but also from a broad HR perspective. Excluding your HR M&A experts early on can become a very costly exercise.

Read about the steps to take regarding pensions when selling a business.

*DB liabilities include post-retirement medical plans, jubilee plans, retirement/termination indemnities, leave accrual plans/sabbatical leave plans


Senior Director, Western Europe Leader for M&A Consulting at WTW

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