Current economic conditions offer M&A bargain hunters a variety of strategic opportunities. But executives focused on plans for expanded product lines and market reach often overlook the need to consider the financial risks, not the least of which includes integration of employee benefit programs such as retirement and medical. The complex process might entail meeting future obligations and complying with both U.S. and international regulations and disclosure requirements.
The accompanying costs are often characterized as minor when the deal price is under negotiation, but with these costs rising around the globe and an increase in administrative and reporting complexities, a lack of proper planning and due diligence may undermine the success of M&A transactions.
“World-class acquirers assess the financial risks with benefits and plan the integration strategy during due diligence. It’s those that wait until after the announcement that run into trouble, since they don’t know what they are getting and can’t change what they’ve agreed to in the purchase agreement,” says Alex Young-Wootton F.I.A., F.S.A., senior international consultant with Watson Wyatt Worldwide. “Risks associated with cost and compliance for employee benefits often arise when the buyer begins to integrate two disparate benefit plans onto a universal platform, only to find the financial impact and integration strategy weren’t given due consideration when the deal price was calculated.”
We have all read about how many M&A deals fail to meet their objectives due to insufficient integration planning. Recent tough economic times only serve to reinforce the necessity for success.
Smart Business learned more from Young-Wootton about the hidden benefit risks that threaten M&A success and the steps executives should take to mitigate them.
Why is due consideration of employee benefits a key driver for M&A success?
Benefits assessment and their subsequent integration play a major role in assessing the true economic value of the target and in retaining key employees, which directly impacts the success of the newly combined organization. Also, it is critical to be able to correctly identify, quantify and allow for the financial implications of the liabilities being inherited.
In addition, the M&A transaction may necessitate compliance with additional regulations, either because a change in control subjects the organization to another country’s laws or the size of the newly combined organization mandates that additional benefits be offered to employees, which need to be reflected on the company’s balance sheet.
The recent fall in equity markets has highlighted the significant risk that pension provisions represent, however in addition to economic factors, a multitude of other factors affecting volatility, cost and competitiveness of the benefits provided need to be considered. Long-term obligations may be underfunded and require future cash infusions to plug these deficits, which can be offset during price negotiations if the financial risk is known, quantified and understood.
Why are employee benefit costs frequently overlooked?
Executives may perceive that retirement costs are relatively fixed and just look at what’s currently on the balance sheet, thus requiring no further investigation, without realizing that they bring with them compliance complexities and integration issues critical to the success of the M&A process. However, many inherited liabilities may bring with them previously not required disclosure requirements and, given the sign-off requirements imposed by Sarbanes-Oxley, executives need to include identification of these costs and risks as part of the early review process.
Which techniques reveal these hidden risks?
Simply, better due diligence, including integration planning before the transaction is complete by examining each element of your company’s benefit plans and those of the target organization. Sometimes the identification process may reveal hidden liabilities, especially around mandatory benefits outside the U.S., because those costs are frequently overlooked, especially by organizations that believe they only have a global ‘DC’ strategy in place. Many companies get confused with the term mandatory, assuming its state or government paid, but this is not the case; the state determines you have to offer the benefit, but the company pays for it.
Identify any accounting implications, including the need to comply with additional disclosure requirements, as well as how the transition to the post-deal benefits platform will take place. Once the liabilities are identified, quantify their value using an approach and assumptions that are appropriate for the purpose. Dollarizing the liabilities will help executives understand their impact on the transaction as a whole and potentially impact the deal price.
What other risk mitigation techniques are effective?
Once the risks have been examined during due diligence, additional techniques can reduce their impact.
■ Attempt to leave the employee plans and their related liabilities with the seller as part of the negotiation process (and get the employee onto your plans for future service).
■ Introduce indemnity agreements that result in post-acquisition price adjustments as a hedge against unforeseen benefit costs or lackluster asset performance.
■ Communicate the possibility of an acquisition to your HR staff early on so they have time to conduct effective due diligence and reflect risks in final purchase price.
■ Don’t lose sight of the need for a competitive package and its value when contemplating the long-term risks associated with employee benefits.
