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