The Exit Factor: Pension pitfalls

I want to talk about pensions. Wait. Don’t run away or reach for the remote control. Pensions have made or broken many a deal and, with the introduction of auto-enrolment, are about to become even more significant for some. For anyone with an eye on an exit, your company’s pension position needs attention and preferably well in advance of any negotiations.


Businesses encumbered with defined benefit pension commitments have always needed to settle on how they intend to present an up-to-date picture of pension commitments.  This usually means considering at least three bases of pension valuation: an accounting deficit or surplus; a cash funding deficit (and there are many different interpretations of this), or a buy-out basis.


How pensions are valued

Stay with me. Putting this as simply as I can, the accounting surpluses or deficits are reflected on your balance sheet based on actuarial assumptions. Cash funding deficits are the pension trustees’ view of what you’d have to pay to bring a deficit back to zero. The buy-out basis is what you’d have to pay a third party (a pensions buy-out firm) to take the pension liabilities off your hands completely. Whilst the balance sheet and buy out view may be relatively well defined, the trustees’ cash deficit can vary significantly.


If business owners and management don’t have a strategy for how to present the pension position, a smart potential buyer (with sharp advisers) will exploit the weakness and seek a discount based on more conservative assumptions.  I’ve seen this make a difference of hundreds of millions in the final price paid for a business.


Disagreements about pensions can also kill deals, often due to lack of preparation on the part of the vendor. Conversely, having a clear picture of your pension valuation in real time (and of the potential improvement in more favourable market conditions) can help immensely.  The market for such tools is growing. 


Make sure you have a strategy

Demonstrating a clear strategy for managing pensions is also beneficial. The market norm is often to seek a deduction in price for the cash funding basis, which is normally greater than the accounting deficit.  You will need a specialist pension adviser to help with suitable arguments to effectively negotiate here.


So, if your business is free of defined benefit schemes you don’t need to worry about pensions when selling your business, right? Think again. And welcome to the world of auto-enrolment.


Auto-enrolment schemes are also affected

Under new rules, UK employers will automatically have to provide employees with company funded pensions up to a certain level. Two and a half million employees are already auto-enrolled, with a further six and a half million due to enter these schemes this year.


The laudable idea is to nudge people towards saving for their dotage, but the additional pension expense may also affect your three year profit and growth projections. Initial experience shows that less than one in ten employees are opting out of auto-enrolment, which is way below the level that many employers anticipated. Take care to make sensible assumptions regarding the ongoing costs or this will be another source of a price reduction for a potential purchaser.


Has a pension scheme affected a deal you’ve been involved in? How? What did you learn that could help others reading this? Share your thoughts below or schedule a meeting if you’d like to discuss your situation more confidentially.

Neil Sutton | Chairman of Corporate Finance
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