Acquisitions mean big changes for numerous stakeholders. The implications for a target company’s total rewards structure can be profound, requiring the buyer to tweak metrics, replace certain awards and often realign the performance management framework to support an integrated post-acquisition rewards structure.
This change management process can be fraught with human capital risks that can undermine the HR leaders’ ability to execute the post-acquisition HR strategy successfully. To mitigate these risks means that as soon as practicable in the diligence process, HR leaders should identify, plan and quantify them, where possible.
It’s crucial to have a disciplined methodology for addressing potential issues. A best practice used by HR leaders to assess risks is by looking at the organization’s current state, establishing a future state and then identifying what they should do to close any gaps.
Pre-Acquisition: Understand the Target’s Rewards
It’s not as easy as compiling a list of plans, participants and potential payouts. The buyer should know how the target makes compensation-related decisions and understand the company’s performance management process. Ask:
- How does the target measure individual performance?
- How does the output of the performance management process (i.e., ratings) affect compensation decisions?
- What, if any, managing of the performance rating distribution exists?
Understanding the link between the company’s performance management system and incentive structures can provide valuable insight into the target’s culture, clues to potential retention risks, and impediments to rewards integration.
Specific considerations should include:
- Annual incentives. Funding of the annual bonus pool and individual allocations should tie to corporate-wide and individual goals and objectives. The buyer should understand how the target funds its annual pool (i.e., ties funding to company performance), the number of participants, and criteria for individual bonus determination. Targets with significant discretion embedded into the annual incentive process can present integration challenges to an acquiring company that relies on more formal bonus allocation processes.
- Long-term incentives. Long-term incentives, generally delivered in the form of equity compensation—such as stock options and restricted stock—can have material embedded value. From a diligence perspective, HR leaders will want to understand the number of outstanding awards, concentration of holdings, compliance with tax rules (e.g., section 409A deferred compensation regulations), and the treatment of outstanding awards in connection with the change in control, which carries with it certain tax benefits and accounting implications.
Buyers are sometimes hesitant about exchanging target equity awards because of dilution or concerns about the associated expense. However, flexibility under the tax rules for setting the terms of the replacement award beyond the more conventional “exchange ratio” approach can reduce the dilution and associated profit-and-loss impact. For target long-term incentive plans (LTIPs) that provide for board discretion on treatment, any decision made by the buyer will result in a compensation expense related to the equity awards in the post-combination period, regardless of whether such awards are accelerated or cashed out at closing or assumed as unvested awards over the buyer’s equity.
- Deferred compensation. Mandatory deferral of compensation, which is increasingly common across many industries, can take a variety of forms. During diligence, the buyer’s HR leaders should focus on the magnitude of the deferred compensation obligation (and associated funding, if any), compliance with tax rules (specifically IRC Section 409A), and whether such balances are to be distributed on the change in control (and associated tax implications).
- Benefit plan liabilities. Liabilities related to employee welfare and retirement plans should not be ignored. The buyers’ HR leaders should perform thorough diligence to understand any transferring liabilities, annual expenses, and cash-funding requirements associated with employee defined benefit pension plans or post-retiree welfare plans. HR leaders should also understand the potential effect that external forces, such as market conditions and health care reform, can have on their operations. Given recent market conditions, for example, defined benefit plans may be significantly underfunded, which can result in large cash contributions post-transaction.
Post-Acquisition: Identify Gaps
While integration risks can be challenging to quantify, HR leaders should assess the areas that present the greatest risk and plan appropriately, mapping each component of the target’s total rewards to the acquiring company’s reciprocal program to identify immediate gaps and needs. The approach described below considers corporate acquisitions in which acquired employees may be integrated into existing structures. In practice, there are many different approaches to establishing total rewards structures post-transaction (many of which may rely on the requirements or leniency of the purchase agreement, which may require certain provisions for compensation and benefits post-transaction).
HR leaders should also assess whether the target’s performance management framework helps improve business outcomes. For example, once the target’s employees are integrated into the buyer’s incentive structures, the performance review process can help facilitate greater differentiation of performance, if that’s what leadership desires.
Below are common post-acquisition structural changes to targets’ HR programs:
- Salaries. Salaries can consume a significant amount of planning and analysis if the buyer chooses to integrate target employees into its salary structure. HR leaders should understand comparative pay for similar roles so they can identify where positions and roles vary. Many buyers go through a structured “job mapping” process to align salaries across the combined organization. A rudimentary mapping matches job titles and descriptions or links positions based on overlapping job codes. (For example, if an “accountant 3” at the acquired company is matched to “job 1234,” a buyer may conclude that this role is similar to its own “senior accountant,” which is also matched to “job 1234.”)
- Annual incentives. A target company’s annual incentive plan will likely need some modification following a change in ownership. At a minimum, the buyer should assess whether performance targets and metrics support underlying post-combination business objectives. More material changes can include those made to the pay mix or the introduction of new performance metrics into the determination of the annual incentive (e.g., corporate-wide metrics or new, behavioral metrics). The buyer’s HR leaders should confirm that the target’s performance management framework supports the changes and that the changes are adequately communicated.
- Long-term incentives. Integrating target employees into the acquiring company’s long-term incentive plan can often prove problematic. Even for similar companies, LTIP participation rates and relative grant values can vary significantly. Of particular importance is the task of identifying those employees who had historically received meaningful levels of equity awards under the target’s LTIP, but who are not expected to participate in the buyer’s LTIP. Another challenge occurs when target employees will receive lower grant values (absolute or perceived) than they did historically. For these employees, it may be necessary or appropriate to provide a replacement benefit or to consider modifications to other compensation structures.
- Benefits. Lastly, HR leaders should consider differences in employee benefits programs and their impact on employees from a financial and employee-experience perspective. During diligence, HR leaders should compare benefit plans (retirement, medical insurance, vacation), even if only at a high level. This preparation can help them anticipate integration challenges, understand changes in annual run-rate costs, and develop the necessary employee messaging and communications materials.
Pre-Plan for Post-Transaction Poise
The launch of the diligence process should be viewed as the time to start building understanding of the target’s total rewards offering, a process that should continue for the duration of the deal. This can help the buyer to structure a post-transaction total rewards program that supports both HR and business objectives.
In so doing, it’s important to consider each element of the target’s compensation and benefits package separately, as well as to assess its total overall value. This perspective can lend insight into where ‘take-aways’ in certain areas can potentially be mitigated by more generous provisions in other parts of the rewards program.
Once leadership has a sense of the changes the deal will entail and a strategy for moving forward, they should also be prepared to come full circle enterprise-wide with a solid, proactive communication plan that appropriately promotes the desired changes, furthers business goals, and nurtures the evolving culture.
Aaron Sanandres is a principal in the Human Resources Services practice at PricewaterhouseCoopers in New York. Andrew Skor is a manager in PwC's human resource services practice in New York.
© 2013 PricewaterhouseCoopers. All rights reserved.
Republished with permission.
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