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Mergers and acquisitions: buyer beware.

Mergers and Acquisitions: Buyer Beware The three most important factors to be concerned about when negotiating a merger or acquiring a company are pension, multi-employer withdrawal and retiree medical liabilities, according to Ethan Kra, a principal and actuary for William M. Mercer Meidinger Hansen Inc.

In recent remarks to members of the New York chapter of the International Society of Certified Employee Benefits Specialists, Mr. Kra said it is important to first determine what pensions plans a targeted company administers. When examining pension liabilities, he suggested looking for unfunded benefits or benefits technically earned in the future but attributable to past service.

For example, take the employee who had worked 20 years by the time of the sale and who decides to retire five years later. That person may have joined the company earning $20,000 a year, could retire making about $36,000 annually and would then be entitled to a $9,3000 pension. About $1,800 of that amount would have been earned during the last five years of service, whereas at the time of sale, the buyer only recognizes $7,500, which was incurred over the first 20 years.

It is important to note whether a company's existing pension plans have enough money to cover these liabilities, Mr. Kra said. Companies may consider dividing the obligation, having the seller take responsibility for the retirees and the buyer take resposibility for the current employees. The company which takes on the obligation would have the benefit of a tax deduction, he said.

An asset sale of a company contributing to a multi-employer pension fund may trigger unfunded liabilities which could greatly affect the buyer. In that case, the purchase price should be adjusted to compensate for the cost of the liability after the extra cost of the plan versus withdrawal penalties have been assessed, Mr. Kra said. Section 4204 of ERISA provides bonding requirements designed to hinder triggering these penalties. A stock sale does not trigger withdrawal liabilities since technically "nothing has occured," he added.

"Retiree medical liabilities are extremely assumption sensitive," said Mr. Kra. "Watch out for a typical retirement plans in certain industries which allow early retirement to those employees whose age plus service equals the floor set by the plan."

To estimate a company's retiree medical liabilities, MR. Kra said that buyers should add the assets and pension plans to the unfunded liabilities and subtract the surplus of pension. "This figure may be 30 percent to 40 percent off, but it indicates whether there is a liability of $1 million or $10 million," he explained.

While there are many liabilities of which buyers should be aware, there are also assets they should review. One assets that few people are aware is interest payments on loans to employees through their 401(k) plans, Mr. Kra said. Provisions of 401(k) plans allow employees to borrow up to half the amount of their accounts if the balance is between $20,000 and $100,000. If the account balance is over $100,000, up to $50,000may be borrowed.

Companies often experience mishaps when acquiring others. Foreign firms, in particular, have problems when trying to acquire American Companies because they are unfamiliar with U.S. practices, Mr. Kra pointed out. The solution to such problems, he stressed, is "proper due diligence."

Much can learned about a company by reading their newsletters and publications. Ina a friendly takeover, the document room os usually left wide open to the buyer. In a hostile situation, public documents may be the only means for gathering information about a company.

The target company's contractual obligations should also be scrutinized, Mr. Kra said. "It is important to keep in mind that a company may have contracts from a previous sale," he added. Before acquiring a company, Mr. Kra suggested that the buyer determine if these contracts can be modified. Past legal decisions have benefitted both buyers and sellers, and as a result, no real precedent has been set.

Mr. Kra also suggested that buyers submit a determination letter to the Internal Revenue Service to find out if their targets' filings have been processed properly. This will uncover any penalties that are imposed on a company or its employees. Under ERISA, a missed 5500 filing could mean a fine up to $1,000 a day. There are also new regulations requiring the auditing of pension plans.

Mr. Kra also reminded negotiators not to forget about accrued vacation pay, retrospective plans, premium drag, disability premium waivers, deferred compenstion and employee contracts and parachutes when determining the purchase price. Furthermore, he said claims incurred and paid after sale are the responsibility of the spin-off company or buyer. If the seller paid the claims, no tax deduction can be made after a sale since its benefits were sold. The buyer, who is able to take the tax deduction, may decide to reimburse the seller.
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Author:Perry, Susan
Publication:Risk Management
Date:Nov 1, 1989
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