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Managing Pay Challenges in an M&A or IPO Deal

Identify key people needed post-transaction, then design incentives to retain them

For any company preparing for a major transaction—whether a merger and acquisition (M&A) or initial public offering (IPO)—the stakes are high. Motivating and retaining key people through what is often a long and drawn-out process is a major challenge for HR executives.

“I have worked through two IPOs, several mergers and acquisitions, and companies going private to public and back to private,” said Jeff Weber, senior vice president of HR for Instructure, a learning management company based in Salt Lake City. “The common thread in all of these transactions is the need for a clear compensation philosophy that evolves as the company goes through different ownership stages.”

A not-yet-profitable private company would probably start out being careful about cost expenditures because of limited capital, Weber noted. Salaries would often be below market, but with enough equity to make up the difference. As the company moves toward an IPO, the compensation philosophy might shift to paying closer to the market midpoint as the company scales back on equity.

But even these practices can vary considerably. “Some pre-IPO companies choose to be aggressive with cash compensation because the challenge of finding talent is so great right now,” Weber said.

Similarly, according to the March 2016 People Risks in M&A Transactions report from Mercer, people risks remain top of mind for both parties in an M&A deal, including such pain points as employee retention, compensation and benefit levels and overall talent management. Moreover, these people-related challenges exist in a highly competitive deal environment featuring truncated timelines, less access to information and increasingly activist shareholders.

Here are some compensation approaches available to help ease the transition as a company merges, makes an acquisition or pursues an IPO.

Targeting Incentives

Big changes like these are unsettling at best for employees at every level. As soon as the transaction is announced (or rumors start flying), employees tend to start updating their resumes and considering their job prospects. Therefore, the first pay-related step company leaders should take is to identify key people needed to complete the transaction and grow the business, and then design the incentives necessary to retain them.

According to the Mercer report, for instance:

  • “Buyers” in an M&A should segment key stakeholder groups beyond the executive team to determine appropriate severance programs, stay and retention bonuses, roles and decision-making authority during and after the transaction.
  • “Sellers” should identify critical employee groups—targeting those that influence key customer relationships or important operating initiatives—and consider a retention program.

Key employees can include everyone from senior-most management to engineers working on a critical product development to sales professionals who handle the company’s most important customers. Major transactions often require a significant amount of work and contributions from a relatively small group of people. Incentives for this group can focus on lump sums paid out on a specific date post-transaction or on the achievement of specific milestones during the transaction. For executives of a company making an acquisition or looking to be acquired, these incentives might be pegged to getting a certain price for the target company.

Retention incentives bring their own challenges.

Retention incentives paid out to people who stay with the company until a certain date bring their own challenges. More specifically, companies need to carefully consider who should be eligible for retention incentives. “Ten or 15 years ago, companies had larger retention budgets and spread them out fairly broadly,” said Dave Kompare, a principal and senior vice president with Aon Hewitt in Lincolnshire, Ill. “Now companies often have limited retention budgets and must take care not to spread them out too thinly, making them less effective.”

Some of these incentives, such as those for key finance and information technology personnel, can pay out at a specific date, say, six or 12 months after the transaction closes. These incentives are likely to pay out a certain percentage of each employee’s pay. For employees considered to be key to the long-term prospects of the company, these incentives are likely to include a long-term component, such as stock options or grants vesting over a two- or three-year period.

Merging Pay Systems

Another challenge is determining whether and how to combine compensation systems for the newly joined entity following a merger or acquisition. In addition to the usual administrative and technology questions that surround this part of the process, chances are good that pay levels between the combined companies will not be an exact match in every case. Therefore, the company must find ways to reconcile pay differences for employees in similar roles.

These differences are not limited to base pay. One side might have broad-based incentives that reach far down into the organization, while the other offers incentives to a much more limited group. In this case, reconciliation would focus on incentive eligibility, with the answer depending heavily on how the new entity is structured.

Compensation questions are likely to be more complex when an acquired business is fully integrated into the buying company. If an acquisition is to be treated as a separately run portfolio company, the organization has more flexibility when dealing with pay differences and may even leave everything as it was before the acquisition.

“There is greater need for compensation alignment when the acquired business is in a similar space or even does exactly what the acquiring company does,” said Kompare. “In this case, the company is likely to fully integrate the employee base and must think carefully about how to align compensation structures based on pay levels and incentive program participation.”

This can be a challenging situation. The company will have to determine why base pay levels for any positions are out of alignment and determine the best way to bring them back in sync. For example, should adjustments be made all at once or over two or more pay cycles?

A newly public company has its own challenges when it comes to pay adjustments. If the company is bringing in new hires at more competitive market rates, it needs to consider how to adjust pay for existing employees. “Another issue is how to refresh equity grants in a meaningful way so employees don’t sell and leave after the IPO,” said Weber. “One option is to make additional grants that layer on top of the existing equity and vest over an extended period of time.”

“Clearly, the stakes are high. The magnitude of these risks means that companies must consider the people issues at the outset if they hope to protect the value of the transaction,” noted Jeff Cox, senior partner and global M&A transaction services leader in Mercer’s Chicago office. “By prioritizing the people and HR issues, and integrating them as an essential part of their deal strategy and planning, companies can significantly improve their chances of success.”

Joanne Sammer is a New Jersey-based business and financial writer.

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