Have you remembered reward in your M&A project?

When undertaking due diligence neglecting any reward costs can lead to a significantly inaccurate valuation and even endanger completion.

In the whirlwind of M&A activity, reward often gets relegated to the backburner.

Focus tends to gravitate towards finance, synergy, technology, culture and operational models.

However, neglecting reward during the early planning stages can have significant consequences.

Why reward matters in the due diligence stage

Unforeseen investments or liabilities associated with reward could cause an M&A to fail due to significantly increased costs such as:

Retention payments or transaction payments triggered by change in control,
The need for reward harmonisation to avoid a two-tiered compensation structure, and
Any pension or benefit provision obligations that would carryover post transaction.

Involving reward early in the M&A process during due diligence is important for a successful transaction.

Understanding value and cost

In sectors where talent is a key driver of value or comprises a significant part of the operational costs, neglecting reward costs can lead to a significantly inaccurate valuation.

During the DD stage, it is important to understand the target firm’s existing cost base for compensation and benefits, including salary, bonus, long-term incentive and equity award (and who would bear the cost of vesting for live awards), as well as benefits and pension provisions.

Retention of key talent

It is also important to understand which key talent is critical to the success of the combined organisation, risk created by equity schemes vesting on the transaction, any existing retention schemes in place and whether new retention schemes are required post-deal.

Recognising differences

A reward DD can provide a comprehensive understanding of the target company's existing reward level and structure, and identify any gaps compared to the buyer’s offering.
For example, if the target’s and buyer’s reward levels differ significantly, there are options to consider going forward.

Either aligning everyone to the same level which could incur costs; or ‘red-circling’ (i.e, freezing higher compensated employees’ reward packages until those of lower paid colleagues doing equivalent work have risen to the same level), but this may have an impact on any pay gap analysis or equal pay positions post deal closure.

This can facilitate early thinking around integration planning if the deal does complete, especially on high priority areas (e.g., will teams from both side work directly together from day one).

Otherwise, the team may face time pressure during the sign-to-close stage to get ready for planned ‘Day One’ operation.

Identifying risk

Another important role reward due diligence plays is to help identify potential risk areas which may not directly impact the deal value but could potentially damage the employer brand in the future.

Examples include no provision for early retirement or pension provisions that are subject to Beckmann Rights (i.e., pension rights that, unlike the usual position, transfer under TUPE), time and offering gaps when switching benefits providers, or any retention risk for executives and key talents.

Considering all of the above, it is good practice to involve reward early in the stage.

How to plan for an efficient reward integration

Once the deal has been signed, there is a limited sign-to-close period to plan for the reward integration.

Although, this period can last several months there are a lot of things for the reward teams to plan for a smooth transition on ‘Day One’.

Top 10 tips to help you effectively plan your reward integration are:

Efficiently use the DD stage to clarify any unresolved questions or missing information;
Make sure there is a dedicated project team consisting of the right stakeholders;
Think about the time framework, develop a project plan with key milestones. Interim provisions may be required if full transfer on ‘Day 1’ is not feasible;
Ensure continued employee engagement and communication throughout the process;
Have agreed reward integration principles and strategy (this supports the value, culture and enables the delivery of your business and talent strategy post deal);
Effectively utilise the time to review and design the go-forward reward structure;
Map existing employees into the new reward structure, to allow an assessment of any material cost impact and the total reward impact for individuals post deal (additionally, it enables planning for the treatment of special populations who may not fit perfectly in the new structure due to TUPE protections);
Ensure there is enough time to engage with payroll, benefits and pension providers;
Ensure a carefully planned data and operational flow among reward, HRIS, Payroll and any other People Technology platforms; and
Ensure effective retention awards are in place to retain key people throughout and post transaction.

Key considerations for carve-out/separation

From the seller's perspective, it is also important to consider the impact on reward policy and provisions when a carve-out or separation occurs, particularly when key HR/reward professionals are included in the deal.

If the carve-out/separation is significant, there is likely to be a need to review the existing grading and pay structures.

There may also be an increase in benefits provision costs due to the loss of economies of scale, and the NewCo being carved out may need to review the overall package alongside the EVP (employee value proposition) to ensure a competitive reward package is offered within the available budget.

Additionally, with a potential strategic and operational focus shift, any incentives under offer may also be subject to review.

Apart from reward strategy and policy, it is also important for the NewCo to plan for any foreseen operational changes (e.g., system or data migration, benefits provider switch, etc).

These should be carefully planned, including consideration of timing, responsibilities, and contingency planning, to ensure a smooth transition.

How can KPMG support you?

KPMG’s Reward Consulting team offers a comprehensive suite of M&A reward services to support you through the transaction lifecycle. Contact the authors Scott Cullen or Susie Zhu for more details or advice.