How to Price Benefit Plan Liabilities: What Acquirers Get Wrong
Buyers should remember that when stretching to get a deal closed, it’s always worth taking the time to get the details right.
Many middle-market dealmakers are pushing for transactions to close sooner rather than later, fearful that any economic upset could shut the window of M&A opportunity against a turbulent election cycle and other volatile trends. Still, buyers should remember that when stretching to get a deal closed, it’s always worth taking the time to get the details right or regret the consequences for years to come.
That’s especially true when accurately assessing liabilities associated with employee benefits. Too frequently accountants and lawyers using financial statements to prepare for an acquisition or merger rely on the liability numbers recorded for convenience under AICPA guidance. However, these figures often bear little relation to the potential real-world liabilities of the plan.
Ascertaining the best representation of a company’s benefits obligations typically leads to a very different purchase price, often reducing the initial sticker price significantly. In one case, an international manufacturing concern was put up for sale at a price of $2 billion, but due diligence revealed that actuaries had miscalculated post-retirement healthcare liabilities to the tune of $140 million (on an FASB basis). The miscalculation was closer to $500 million using more realistic discounted cash flow projections. In the end, the deal closed at a final purchase price below $1 billion.
Firms considering mergers should watch out for these common missteps:
Beware the Details. FASB Accounting Standards Codification requires certain inflation and interest rates, but those assumptions rarely produce liabilities that equal the present value of cash outlays. There are many ways to calculate a liability, so make sure you know which standard assumptions and methods are being used. Liabilities and expenses should be adjusted accordingly.
Ask Questions. Buyers should ask probing questions of the actuaries, accountants, and lawyers of the selling company and uncover what is not reflected in benefits liabilities data. The answers might reveal some surprising facts and figures that can speed up getting the deal closed at the right price.
Include Reasonable Forecasts. Health-care costs have risen faster than are reflected in most long-term focused financial statements. Adjusting these numbers for coming years often results in vastly different forecasts than those recorded in financial statements. If a financial statement assumes health-care costs will rise only at 4 percent annually (as they did last year) but premiums actually rise an average of 6-10 percent yearly for the next decade, then liabilities will be significantly different.
Make Contingencies. Companies negotiating mergers should account for the possibility that laws might change, resulting in previously unforeseen liabilities. For example, if you bought a company before the Affordable Care Act took effect in 2010, you might now have to provide benefits not previously expected.
When Were Valuations Made? Companies that provide richer benefits, such as Fortune 500 firms or mature companies such as manufacturing firms, are more likely to inappropriately value a transaction by miscalculating benefits because assumptions underlying their plans could be significantly outdated.
Correctly pricing benefits liabilities is vital to completing any deal at the right purchase price. Once a transaction closes, the acquiring company is stuck with legacy liabilities and will have to pay out, whether the transaction value adequately covered the underlying obligations or not. Cutting benefits is rarely an option because that could prompt an employee exodus, undermining the value of the deal.
Joe Rankin leads Plante Moran’s Employee Benefits Consulting practice.