HR innovation Fall 2012

HR innovation
Fall 2012
02
Don’t get done in by
a done deal: Avoid
postdeal pitfalls
by managing HR
complexities
08
Transactions,
change, and talent:
Managing talent as
deals and outside
influences reshape
the healthcare
industry
14
Employment
considerations
behind the Great
Wall: Thinking of
checking out China?
Labor and talent
challenges you
should know before
you go
18
Divulge with
diligence before you
divest: Know your
HR metrics to make
the most of the deal
Contents
Foreword01
Scott Olsen, US Leader, Human Resource Services
Don’t get done in by a done deal: Avoid postdeal pitfalls
by managing HR complexities
02
Nadirah Ibrahim and Sushil Ahuja
Transactions, change, and talent: Managing talent as deals and outside influences reshape the healthcare industry
08
Hector H. Mislavsky, Sarah Tunku Mu’Tamir and Teresa Yannacone
Employment considerations behind the Great Wall: Thinking of checking out China? Labor and talent challenges
you should know before you go
14
Eric Wheeler
Divulge with diligence before you divest: Know your HR metrics to make the most of the deal
Jim Dell
18
From diligence to close to Day 1
and future state, the transaction
landscape can be filled with
obstacles both hidden and overt.
Foreword
Transactions comprise myriad moving parts and human resource issues
are a pivotal part of the mix. Not all stakeholders, though, recognize
the importance of the HR factor in realizing deal success and business
goals. Yet, buyers and sellers and those expanding into new markets
face a wide range of decisions with respect to talent. From legal and
contractual obligations to compensation and benefits, deals inherently
affect talent, which in turn significantly influences long-term deal
viability and competitive positioning.
Business trends such as globalization
and convergence in industries such as
healthcare are speeding the pace of
transactions, even as the deals themselves are reshaping individual companies and entire industries. Viewing these
deals through an HR lens will increase
the likelihood that they will deliver. To
attain such high-value insight, you’ll
need thorough preparation and planning.
An HR sensibility can inform negotiations and other aspects of the transaction
with data and analysis that bring clarity
to the many questions that can arise in
the heated transaction arena:
Who should fill strategic positions? Who
should be retained or transferred? How
will overtime and other employment
laws affect overseas operations? Which
party will support payroll and the human
resources information system? What
retirement benefit obligations will carry
over? Who will fund bonus payments?
Will this trigger tax obligations? How
will you keep top executives from
walking away? How will you structure
HR in a merged or divested company?
In this issue of HR Innovation, we delve into
what it takes to answer these questions and
to realize the potential value of mergers,
acquisitions, dispositions, joint ventures,
and other deals. I hope you’ll enjoy gaining
the insights offered in these articles:
• Don’t get done in by a done deal:
Avoid postdeal pitfalls by managing
HR complexities
• Transactions, change, and talent:
Managing talent as deals and outside
influences reshape the healthcare
industry
• Employment considerations behind
the Great Wall: Thinking of checking
out China? Labor and talent challenges you should know before you go
• Divulge with diligence before you
divest: Know your HR metrics to make
the most of the deal
From diligence to close to Day 1 to
future state, the transaction landscape
can be filled with obstacles both overt
and hidden. But with the right tools and
preparation, you can navigate the maze
of critical talent-based decisions that can
support deal success, shorten the time to
close, and boost value.
Scott Olsen
US Leader, Human Resource Services
HR Innovation
1
Don’t get done in by a done deal: Avoid
postdeal pitfalls by managing HR complexities
By Nadirah Ibrahim and Sushil Ahuja
Carving a business out of a larger organization often presents
a high degree of complexity when it comes to disentangling the support
functions from the parent company. For HR and other functions that
tend to rely heavily on the parent’s corporate support and infrastructure,
transitioning to the point at which they can stand alone or be fully integrated into buyers’ existing operations brings its own set of challenges.
2
But you don’t have to risk losing your
talent and productivity that often
results from business transactions. You
can promote a successful HR transition
during a business separation by moving
effectively from diligence to transition,
using a thoughtful and guided approach
to time constraints, and balancing
transition-related to-do’s with routine,
day-to-day objectives. We’ll take a
deeper dive here.
Moving effectively from
diligence to transition
A successful transition requires the
buyer and seller to understand clearly
and manage the support needed for HR
service delivery and its many forms.
First, the negotiating parties should
focus on achieving an effective transition from diligence. It’s important to
understand the nuances and how the
final sales and purchase agreement
terms were developed. Was the process
contentious? What was the starting
position? Did the negotiating parties
push back? Understanding the history
and context of the final agreed-upon
terms can help put the entire deal into
perspective.
With that in mind, it’s also critical to
have a clear understanding of what was
included in or excluded from the deal
financial model—which programs are
retained, whether the buyer or seller is
responsible for which costs and for what
time period. The integration plan should
reflect these clear divisions to limit
any disconnect between the financial
model and the actual realized costs once
programs are up and running.
The buyer shouldn’t expect perfect alignment between the preliminary estimates
modeled during diligence and actual
realized costs. However, proper planning
can avoid unexpected financial impact
that might arise from fundamental shifts
away from the deal terms.
In addition, the buyer’s expectations
for growth and synergies should stand
at the forefront of integration planning.
The transition approach will affect
the buyer’s ability to realize short- or
long-term goals.
Taking a step back, buyer and seller
should keep tabs on separation issues
while still early in the diligence stage
and assess both parties’ appetite for a
transition service agreement (TSA).
For example, to the extent the carvedout company has no HR infrastructure
or programs of its own, some level of
continued support under a TSA would
be needed.
Sometimes the seller has no issues
providing payroll and HR systems
support during the transition phase
but they might have concerns about
allowing continued benefit plan
participation under a TSA. This may
pose a problem as employees need
coverage until the transition is complete
and programs and systems are up and
running in the new company. If the
seller is resistant or unwilling, the
buyer might have to consider alternatives, such as an employee leasing
arrangement.
HR Innovation
3
Using timing constraints to
guide integration approach
The timing, objectives, and requirements
of the deal may dictate the strategic
approach to integration. The period
between signing and expected close can
be as short as two or three months or
as long as 18 months. If the timeframe
is short, the buyer must confirm if the
seller will provide continued support
for HR transition under a TSA. If so,
a detailed inventory of the types of
support needed and associated costs,
as agreed upon in the TSA, should run
parallel to the integration plan.
If no infrastructure exists but the
business needs to function on a standalone basis, establishing the critical
Day 1 needs, such as payroll, HRIS, and
benefit plans, typically requires 20 to
24 weeks. The lead time may shorten if
the acquired business will merge into
the buyer’s existing operations. This
depends on factors such as capabilities of existing vendors and resources
available to devote significant time and
effort to an effective integration.
In addition, you should balance the
need for speed in coming off the
TSA while giving adequate time for
making crucial decisions about the
HR operating model, including:
• Whether to keep HR functions
in-house or to outsource them
• Whether HR systems support
the organization’s short- and
long-term vision
4
• How to design and implement the
right employee reward programs
• How to design the HR organization
and have people with the right capabilities and skills in place to support
the new organization, its growth
goals, and geographical footprint
Implementing the latest technology
without regard to whether the current
staff have the right skillset and perform
at the appropriate level is a waste of
resources and can lead to problems later.
This can usually be addressed by ensuring
that appropriate training programs are
baked into the transition plan.
Depending on the variables at play in
a carve-out transaction (deal terms,
timing of sign to close, level of TSA
support), a short timeframe for setting
up stand-alone operations would by
default limit the approach to a cloneand-go strategy. Such an approach basically mirrors existing benefit plans and
systems and retains current vendors.
On the other hand, a longer timeframe
provides greater flexibility for customizing the integration strategy. Placing
the various programs out to bid yields
the opportunity to shop for a vendor
that’s better suited to the new employee
population, business objectives, and
cost structure. Employers may need
to consider different service providers
when moving from a 20,000-plus
employee group to 2,000, or merging
400 employees into a 900-plus combined
organization.
In addition, the buyer can pair shopping for new vendors with a complete
or partial redesign of benefit programs
and systems—if time is sufficient
for wholesale change. The buyer can
realize further efficiencies from overhauling and streamlining benefits to
confirm that programs are right-sized.
However, the new company will need
to ensure rigorous testing is done and
timely and comprehensive communications delivered to minimize issues and
limit employee disruption.
This redesign approach assumes the
absence of covenants that stipulate
specific employment terms and
conditions that must be maintained
for a certain time. In all likelihood,
the deal terms would include a maintenance period of one to two years for
comparable compensation and benefits.
If so, in the short term, each program
would continue as is, or perhaps run
parallel to existing buyer programs.
The buyer would need to phase in any
redesign later.
As a buyer, planning your deal timing
and determining the right sequence
of steps should begin with an understanding of the interdependencies of the
multiple events that will occur during
the transition. You should determine
the timing of implementation and the
targeted go-live date and work backward from these. Note critical dates
such as legal deadlines or when you
might need to merge benefit programs
to meet testing requirements.
Start with the items that absolutely
need to be realized from Day 1. Follow
with events that can wait until the
basic pieces have fallen into place. Most
importantly, build some flexibility into
the transition plan and anticipate and
prepare for potential complications.
Issues with vendors unable to replicate
or meet the requirements may arise.
Other factors may cause a shift in
timing, so you must be able to switch
gears quickly and not let these issues
derail your transition plan.
Managing Day 1 integration tasks
along with day-to-day needs
As you focus on important tasks to
address Day 1 readiness, you must
continue to manage day-to-day operations effectively. In general, the work
streams within an HR transition process
and the associated tasks, with some
interdependencies, are:
• HR Infrastructure and systems:
Design anticipated HR infrastructure
(full suite of human capital management, payroll, HRIS, and talent),
Implementing the latest technology without
regard to whether the current staff have the right
skillset and perform at the appropriate level is a
waste of resources and can lead to problems later.
HR Innovation
5
including staffing and anticipated
technology requirements. Identify
the right technology solutions and
models, such as cloud computing,
outsourcing, and on-premise technologies. Consider the appetite for
wholesale change, weighing in cost,
resources, and timing available.
Develop thoughtful planning for
transition and implementation.
• Benefits: Review plan design,
funding, and vendor management
strategies for retirement and health
and welfare plans, including qualified, statutory, and supplemental
programs. Develop a transition
plan to select and implement new
programs. Review communications
and enrollment needs.
• Compensation: Review and design
plans, including short- and longterm incentives and equity-based
compensation. Negotiate employment agreements with senior
executives. Review existing bonus
targets and metrics.
• Organization structure: Develop
or modify organizational structure
for reporting and accountability to
the buyer’s existing management
team, recognizing that the futurestate structure need not be fully
baked at Day 1. Address immediate
business needs by developing an
interim HR organizational structure
through the transition to address:
(i) key management and leadership
positions needed to run the business
and (ii) ‘bubble resources’ needed
to deliver on integration activities.
Clearly define roles and responsibilities and reporting relationships and
6
tap external specialists to augment
internal resources during integration. Once stable, address long-term
business needs by developing a
steady-state organizational structure
that supports organization end-state
vision, including transition of bubble
resources, such as decision rights,
design performance, and compensation management.
• Employee transition and
retention: Establish a hiring and
onboarding process, visa requirements, and compliance with local
labor laws for offer letters, terms,
and conditions. Identify pivotal
talent; and assess and develop
retention plans and severance
obligations consistent with modeled
costs and compliance with local
laws and contractual requirements.
Obtain necessary notices and
approvals. Involve labor counsel in
the employee transition process and
transfers of employment contracts.
• Labor groups: Develop strategies to
engage with unions and works councils and plans to address consultation
requirements. Assess the impact of
historical labor relations and deal
timing on upcoming negotiations.
• Compliance and governance:
Assess regulatory filing and
reporting requirements and
develop a plan to address related
needs. Establish compliance and
governance processes. Develop or
align policies and procedures and
document updates to employee
handbooks.
• Communications: Develop a
communications plan to ensure
consistency in messaging across
various channels and groups,
and process to address questions
and answers. Promote targeted
messages for:
1.
Internal HR-related
communications targeting
employees
2.
Internal non-HR-related
communications
3.
Communications targeting
external stakeholders
Meeting additional postdeal
HR challenges
In deciding on an HR delivery model
you have many options—whether to
manage with in-house or outsourced
resources or a combination the two.
You should carefully consider the
overarching vendor strategy and
available options in terms of the fee
structure relative to the level and
quality of service delivery. During
the delicate transition stage, you
should balance cost against the risk
of jeopardizing a smooth process.
After you choose your strategy, timing,
and approach, you should obtain buy-in
from other stakeholders and allow for
their input. Stakeholders include deal
sponsors, other functional leaders
(including finance, tax, and IT), and
the internal HR team that must deliver
the programs on an ongoing basis and
act as the daily contact for employees.
You should strive for consistency in
approach, for example to align the HRIS
solution with the broader IT strategy.
Developing a strategy to measure employee engagement is
also critical in achieving a smooth transition.
Employee behavior directly influences
customer behavior, and customer behavior
Legal involvement is essential, not only
in the pre-deal stage, but also through
every step of the transition process. This
includes employee communications, the
contracting process, and compliance
requirements on benefit plan design and
the employee transition. Any missteps
can prove costly by way of litigation,
regulatory penalties, and nonmonetary
impact on employee relations.
Get employees on board and engaged
by communicating early and often, with
thoughtful and consistent messaging
across all channels. Feedback from
employees or other stakeholders may
sway the transition approach. Change
may come in the form of any special
consideration or a potential deviation
from the initial plan to the extent that it
does not have significant cost or downstream implications.
Developing a strategy to measure
employee engagement is also critical in
achieving a smooth transition. Employee
behavior directly influences customer
behavior, and customer behavior directly
affects revenue growth and overall
profitability. So, you can’t overemphasize
the importance of measuring engagement levels through surveys and other
means, factoring the insights into the
new entity’s business objectives.
Finally, change management plays a
big part in preparing employees for their
roles in the new entity, and communication is most effective when leaders
explain the reasons for decisions.
directly affects revenue growth and
overall profitability.
Through change management, leaders
begin to paint for employees a picture of
the future, which is critical to retaining
and engaging talent.
Establishing a strong project management office, to create work streams and
identify decision makers to address
critical HR issues as early as possible, is
crucial for success. You should confirm
that the management team will help
reinforce the central messages to
employees. This will help avoid inconsistencies in communicating the many
changes that affect all layers of the
organization during the early days.
As a buyer, you must consider the many
aspects of an HR transition. Start by
using the diligence efforts to effectively
plan around timing constraints. Then
manage resources to tackle the many
work streams and the communications
and change management that should
run parallel through the HR separation
process. With thoughtful planning and
execution of the separation steps, the
transition to the new organization need
not be a time of turmoil, but rather an
interim stage in which you can better
prepare and energize employees to
contribute toward a successful future.
HR Innovation
7
Transactions, change, and talent:
Managing talent as deals and outside
influences reshape the healthcare industry
By Hector H. Mislavsky, Sarah Tunku Mu’Tamir
and Teresa Yannacone
Healthcare is in a state of dynamic, dramatic change,
even as numerous players revamp their business models through
consolidations, mergers and acquisitions, dispositions, and joint
ventures. How healthy is all this change for leadership’s ability to
manage talent and talent costs? That depends on their ability to
make human resources a priority, even as operations whirl toward
a future state and the industry undergoes an overhaul. We’ll take
a look at healthcare industry changes and their implications on
two of the major players—pharmaceuticals and hospitals.
8
The new world for
pharmaceuticals
The change:
Vertical and horizontal changes are
spurring new ways of doing business.
These encompass expiration of blockbuster patents, heated competition from
generics, expansion into new areas
along the supply chain, and exits of
areas such as animal health or consumer
products. Other factors reshaping the
industry include companies striving to
take advantage of economies of scale,
expanded R&D, advancements in biotech
research, and stricter governmental and
international regulations.
The challenges:
Several critical human capital issues
may arise in the course of pharmaceutical transactions. During diligence,
these typically include measuring the
cost of redundancies and reductions in
force, which typically stem from duplication in functional areas, consolidation
of sales forces, closing of manufacturing
facilities, or moving manufacturing to
lower-cost geographies.
Outside the United States, and in
particular in Europe, these issues may
be more pronounced because statutory requirements can make employee
terminations substantially more expensive. These costs can be offset, however,
by longer-term savings from synergies,
economies of scale, and sourcing labor
in lower-cost jurisdictions.
Inevitably, at the executive level,
change in control payments will have
to be measured. These include cash,
equity, perks, and possible tax gross-up
payments, particularly in the United
States. These payments could lead to
executive retention issues post-transaction, which will need to be taken
into consideration when designing
any post-transaction compensation
arrangements.
More traditional pharmaceutical
companies likely will face large pension
and other postretirement benefit
obligations. Despite recent gains in
investments supporting funded plans,
liabilities are increasing even more
rapidly as interest rates continue to fall,
remaining at historical lows; there are
no expectations of near-term increases
in interest rates in sight as world economies continue to struggle. Further,
unfunded plans have experienced no
relief from the asset side as their liabilities also have grown.
These issues, either individually or in
combination, can lead to substantial
purchase price adjustments during
transactions; the issues are similar
in the case of acquisitions, dispositions, joint ventures, or other business
arrangements, and need to be reviewed
from the perspective of both parties
involved, buyer and seller.
For example, if a pharmaceutical
company were to spin off a large business unit, how would it treat retirement
benefits? Would the parent company
retain the assets and liabilities associated with the spun-off employees, or
would it arrange to transfer assets and
liabilities to the buyer? If the latter, how
would it determine assumptions and
methodologies, keeping in mind specific
country statutory requirements?
HR Innovation
9
If retention bonuses will be provided to
employees of the spun-off unit, when
would they be paid? Which party would
establish the bonuses, and which party
will be responsible for them? Will there
be a transition services agreement, and
if so, what will be the terms? If a joint
venture, from which party would the
employees come?1 Which compensation and benefits programs will prevail
post-transaction?
Answers to these questions, and
an understanding of the impact of
purchase accounting, which also can
differ depending on the specifics of the
transaction, should be a consideration
in any diligence exercise.
As the transaction approaches closing
and beyond, workforce integration can present critical challenges.
Depending on the size of the acquisition, comparing and rationalizing
pay structures, benefit programs, and
organizational design can be extremely
challenging. For example, who gets
selected for strategic positions? What is
the mix of compensation and benefits
(e.g., there was equity-based compensation before, but there is no equity
opportunity going forward; or, likely,
bonus metrics differ)?
An often overlooked element of
transactions, large and small, is the
cultural differences between the two
organizations. To address this issue,
first, management should recognize
the existence of such differences and
identify them. Not doing so may jeopardize the transaction’s effectiveness.
Second, management should determine
how the differences will be bridged.
Third, it’s crucial to have in place a
strong and robust change management
process to guide employees through the
transaction and its inevitable changes.
Further, has there been an assessment
of the flight risk of top talent? Finally,
management cannot ignore the operational side of the transaction and its
impact on the people involved. It’s
critical to confirm that HR systems such
as payroll and benefit administration
are in place post-transaction.
The new world for hospitals
The change:
Here, too, vertical and horizontal
changes spur transformation. Hospitals
are seeing the formation of more and
larger accountable care organizations (ACOs), expansion of healthcare
systems, increasing collaborations and
joint business arrangements, massive
data analytics, and broader use of telemedicine. Other factors, such as healthcare reform’s regulatory oversight,
pay-for-performance mandates, health
insurance exchanges, and entities
striving for improvements in economies
of scale are also reshaping providers’
operating and financial landscapes.
1 Sometimes, one party provides employees and the other provides capital.
10
As the transaction approaches closing
and beyond, workforce integration can
present critical challenges.
The challenges:
Hospital transactions (and to a large
extent, large educational institutions
with medical centers) have their own
issues that need to be addressed, many
of which are similar to those of pharmaceutical transactions. For example,
hospitals, like pharmaceuticals, will
need to measure the cost of redundancies and reductions in force from
functional areas and other consolidation. Similarly, savings from synergies
and the existence of traditional defined
benefit and other retirement plans will
offset some of these costs.
Because hospitals tend to have large,
unionized workforces, prior to any
transaction, they must thoroughly
assess several critical areas, including:
• Understanding the status of existing
labor agreements and any termination or renewal dates
• Key areas of concern in labor relations, for example, recent strikes
• Contractual arrangements for
other hospitals operating in similar
geographic areas, such as if two
hospitals are near one another,
which union will represent
employees post-transaction?
HR Innovation
11
From an operational perspective, the
impact of healthcare reform will be
substantial. The formation of ACOs
(which place financial responsibility on
healthcare providers to improve care
management and limit unnecessary
spending) will forever alter the way
care is delivered and the way physicians
and their staff are integrated into the
healthcare system and compensated.
On the human capital side of the transaction, hospitals employ large numbers
of part-time employees. Accordingly, a
by-product of healthcare reform is the
expansion of medical benefits to parttime employees who work at least 30
hours per week, if such benefits are not
already provided. If these employees
are not currently covered, hospitals will
need to assess the additional cost. If
necessary, to avoid incremental costs,
hospitals might need to shift schedules
to keep part-time employees within the
30-hour limit. And, if shifting schedules turns out to be the approach, then
operations will need to be revamped to
accommodate such a change.
As hospital transactions approach
closing and beyond, integration of the
workforce can present its own issues.
For example, despite the proximity
of many hospital acquisitions, it’s
possible that the way the parties in
a transaction pay employees differs
significantly. Harmonization of total
compensation and policies is complex
and time consuming and goes to the
heart of the ‘me’ issues that executives and employees experience during
transactions.
12
Cultural differences also can be substantial. If two hospitals
are near one another, integrating the varying cultures can
be a challenge...
...As an example, if one hospital has a
religious affiliation and the other does not,
Further complicating the issues,
geographies are changing. While the
majority of historical transactions were
local in nature, tomorrow’s transaction landscape includes health systems
expanding nationally and, in some
cases, internationally (especially in
the case of academic medical centers).
Understanding the human capital
nuances of various regions or countries
is critical to the success of these transactions. Most provider organizations,
however, have little to no experience in
international expansion.
Cultural differences also can be
substantial. If two hospitals are near
one another, integrating the varying
cultures can be a challenge, particularly when the two workforces are so
close to each other that they can see the
differences clearly. As an example, if
one hospital has a religious affiliation
and the other does not, the organizations may face any number of cultural
or other barriers to integration; in some
instances, such differences can stop
the transaction from closing. Lastly,
the extent of union versus non-union
the organizations may face any number of
cultural or other barriers to integration.
workers and which unions are involved
can present its own cultural integration challenges, e.g., if two hospitals
with two different unions merge, which
union will prevail?
Challenge is woven into the texture of
the transaction process. But in healthcare, the overall state of an industry in
flux magnifies the challenges and the
stakes. Those in the industry can stay
ahead of the game with careful planning, diligence (including a healthy
dose of scepticism), and post-closing
execution and monitoring.
HR Innovation
13
Employment considerations behind the
Great Wall: Thinking of checking out China?
Labor and talent challenges you should
know before you go
By Eric Wheeler
China continues to bask in its popularity as an alluring destination
for companies drawn to emerging markets and the growth opportunities
they offer, but there are a few things to consider before venturing into
business on the other side of the world. This is keenly relevant for those
seeking to grow through acquisition. Among the country’s challenges
amid a rapidly changing workforce and a national shift away from strict
state control: wage inflation, employment regulations, and the implications of acquiring a formerly state-owned enterprise. Read on to gain a
quick view of what you should know before you go—and grow.
14
1. Wage inflation: Perhaps the
most critical and widely discussed
employee-related consideration
is the impact of wage inflation.
While it’s difficult to get reliable
national data, and wage inflation
varies significantly by industry and
province, estimates typically put
wage growth in China somewhere
between 20% and 30% per year.
Although lower today, the cost of
outsourcing or manufacturing in
China will rapidly catch up with the
rest of the world.
In addition to rapidly increasing
manufacturing costs, wage inflation
also tends to result in high employee
turnover when workers are easily
enticed away from their current
jobs by the promise of a doubledigit percentage pay increase.
While this presents a challenge to
employers seeking to fill unskilled
or low-skilled jobs, it can translate into significant recruiting and
training costs for more highly skilled
positions.
2. Employment regulations:
Another major risk that gets
considerably less press is compliance
with employment regulations.
While China places a number
of regulatory requirements on
employers, we’ll take a look at
several that can present significant
risk to an acquiring entity:
• Underpayment of social insurance: Social insurance in China
covers a basic state pension, medical
insurance, employment insurance,
worker’s compensation, maternity
leave, and a housing allowance.
The level of contribution varies by
city but can be up to 50% of payroll
for the employer and up to 30% of
payroll for the employee. Inadequate
controls can cause employers to
underreport payroll—an error they’ll
have to correct; once it’s discovered,
the employer is required to pay all
previously unpaid social insurance
amounts.
Because international acquisitions tend to draw the attention of
regulators, underpayment of social
insurance is a fairly common issue;
employers can find themselves
in the position of owing significant payments at or shortly after
closing. During transactions, it’s not
uncommon to see previous underpayment of social insurance equal to
50% of total annual personnel costs.
Additionally, previously understated
social insurance also can result
in higher-than-expected future
personnel costs.
• Employment contracts: Rather
than being employed ‘at-will’, as is
common in the US, employees in
China typically have employment
contracts that detail the terms and
conditions of employment for that
individual. Local statutes detail
when employment contracts must be
signed and whether an employment
contract can be fixed term or open
ended. Without ‘at-will’ employment, employees have employment
contracts that need to be signed soon
after the employee is hired. Failure to
obtain a signed employment contract
on time can result in significant
HR Innovation
15
fines, often equal to two months of
the employee’s pay for each month
that the contract remains unsigned.
If no employment contract is in place
for an extended period of time, the
employer may forfeit the option of
signing the employee to a fixed-term
contract and be required to implement an open-ended contract.
To avoid the restrictions of openended employment contracts, many
companies prefer to use fixedterm contracts whenever possible.
Employment contract regulations
may limit the length of time that
an employee can be on a fixed-term
contract as well as the number of
consecutive fixed-term contracts
that may be implemented. Failure
to convert an employee from a fixed
term contract to an open-ended
contract when required may result in
a significant fine.
Employment contract regulations may limit
the length of time that an employee can
be on a fixed-term contract as well as the
number of consecutive fixed-term contracts
that may be implemented.
16
• Overtime compensation: Chinese
companies may be required to pay
overtime wages which generally
range between 150% (weekday
overtime rate) and 300% (holiday
overtime rate). Overtime wages
are typically paid to all employees
with potential exceptions for certain
positions such as sales and senior
management. For these positions to
be exempt from overtime compensation, employers may be required to
obtain consent from the national
labor bureau. If a company has
not obtained an exception and an
employee files a claim for overtime
compensation, the company could
be required to pay damages to the
employee, such as back-pay for
historical overtime work.
In the case of employees who are
entitled to overtime compensation,
regulations may impose limits on the
amount of overtime they can work in
a given month (which is typically 36
hours.) Such restrictions may limit a
company’s ability to meet spikes in
demand with its current workforce.
• Statutory vacation: Employees in
China may be entitled to minimum
levels of paid vacation each year,
which are often linked to the
employee’s length of total working
experience (minimums typically
range from five to 20 days per year).
At the end of the year, unused vacation days may be required to be
cashed out, which is typically at a
rate of about three times the daily
pay rate. This liability is typically
triggered when an employee files a
claim for unused vacation time.
3. State-owned enterprise (SOE)
conversion: Because healthcare and retirement benefits are
provided through state-sponsored
social programs, Chinese companies
typically don’t have large legacy
employee-related liabilities such
as the pension obligations and
termination indemnities that are
more common in the United States
and Europe.
However, SOEs provide postemployment benefits (pensions, medical
benefits, long-term care insurance,
and dependent benefits) that are
separate from statutory programs
and are the responsibility of the
company. If an SOE is converted
to a private company, prospective
benefits will generally be provided
through the social security system,
but the company retains the legacy
obligations that were earned prior to
conversion. Such obligations can be
quite significant and may be underaccrued locally compared to IFRS or
US GAAP reporting requirements.
While these challenges won’t deter
most companies from expanding into
China, it’s essential that potential
acquirers venture into the market
with a solid understanding of the
risks that go along with the opportunities. Careful due diligence,
thoughtful planning, and knowledgeable advisors are critical to
the success of Chinese acquisitions
and long-term growth.
HR Innovation
17
Divulge with diligence before you divest:
Know your HR metrics to make the most
of the deal
By Jim Dell
HR’s influence over divestiture outcomes can mean the differ-
ence between a garage sale deal and one that takes place in a
designer boutique. Human resources professionals can play a vital
role in the divestiture process and increase deal value. The key?
Accurate, complete, and transparent information that enables the
buyer to make decisions on the strength of relevant facts. Absent this
knowledge, buyers often feel forced to rely on overly conservative
assumptions, which translate into lower bid prices.
18
Sellers can avoid this trap, as well as
deal failure, missed value targets, and
a protracted timeline, by following a
thorough and thoughtful divestiture
planning and preparation process.
• Health and welfare benefits
• Executive and upper-level
management matters, including
equity compensation
• Retention of key talent
A thorough process that covers three
critical financial metrics is the hallmark of a well-executed, successful
divestiture:
1. The development of stand-alone
HR and benefits costs relative to
historically allocated costs
2. One-time separation costs for
the buyer to replicate total
rewards programs and HR
infrastructure
3. Identification of unfunded obligations along with a clear plan
for who will be responsible for
post-closing obligations
Each of these metrics can impact
overall deal value and result in different
viewpoints from a buyer’s perspective, depending on the level and clarity
of information provided during due
diligence. By identifying key value
drivers upfront, sellers can reduce the
deal timeline and increase the overall
purchase price. The seller should bring
to the forefront all issues that the buyer
might uncover and address them during
diligence and negotiations following a
well-planned strategy. Important areas
of focus for HR include:
• Employees who will transfer to
the buyer
• HR infrastructure
While each deal has unique characteristics in terms of the type of business,
industry, and overall deal and investment strategy, the main areas of focus
for HR remain consistent. The relative importance of each area varies,
however, with each deal.
Stand-alone costs
In determining purchase price, buyers
often use a multiple of adjusted pro
forma earnings with adjustments based
on a number of factors. These include
the impact of operating the business on
either an integrated basis (in the case of
a strategic buyer) or a stand-alone basis
(in the case of a financial buyer).
A business unit within a larger company
might have a substantially different cost
structure compared with one that operates on a stand-alone basis. To reduce
guesswork and resulting overstatement of the stand-alone cost impact,
successful sellers anticipate incremental
costs (and occasional savings) and
present this information to buyers. A
stand-alone cost build-up particularly
interests financial buyers who may not
have an existing infrastructure into
which they can fold the asset or business unit.
• Pension and other retirement
benefits
HR Innovation
19
Fully integrated companies with functional
support from the corporate office in areas such
as HR, finance, legal, and enterprise-wide
systems and processes often find the separation
process complex, time consuming, and costly.
One-time costs
In addition to stand-alone costs, onetime costs often are associated with
divesting from the parent company.
The level of costs varies based on how
integrated or separate the business
unit historically has been run.
Fully integrated companies with functional support from the corporate office
in areas such as HR, finance, legal, and
enterprise-wide systems and processes
often find the separation process
complex, time consuming, and costly.
To lessen the likelihood of purchase
price reductions associated with the
separation, sellers can evaluate potential
efficiencies by completing some or all of
the separation prior to the divestiture.
Unfunded obligations
Sellers should evaluate unfunded
employee-related obligations associated with compensation and benefits,
determine materiality, and develop a
point of view as to the desired postdivestiture owner. Depending on the
situation, sellers may be able to increase
deal value based on the approach used
in addressing the obligations in the
purchase agreement.
Buyers often prefer an ‘our-watch-yourwatch’ approach, where the seller is
responsible for costs and liabilities that
arose pre-close or were triggered by
20
events that occurred pre-close, because
the seller retains historical obligations
and continues to manage them postclosing, rather than the buyer inheriting
the obligations and associated costs
and risks. Sellers will want to understand the implications of this approach
compared with other approaches in
terms of the impact on the number of
interested buyers, deal timeline, and
purchase price.
Workforce considerations
As early as possible during the sale
preparation process, the seller should
identify employees who will go to
the divested company. For many
companies, labor is the largest cost
component. Sellers therefore should
not overlook potential opportunities
to identify cost synergies that buyers
would be willing to reflect through a
higher purchase price. For example,
sellers may want to evaluate pre-sale
staff redundancies to lessen the seller’s
potential severance obligations and
accelerate growth in profitability.
Buyers will evaluate whether historical
costs fully accounted for the employees
needed to run the business and the
level of shared services employees
(such as payroll and benefits administration) who may also support other
business units of the seller. To the
extent allocated labor costs don’t reflect
what’s needed to operate the business, depending upon the facts and
circumstances, the seller might propose
adjustments to pro forma earnings and
provide supporting documentation.
These adjustments might increase or
decrease potential value adjustments
buyers make. To decrease the burden
to the buyer and lessen post-closing
disruption, sellers might also transfer
some employees who previously
supported other areas of the company
to the unit being sold.
Pension and other retirement
benefits
Defined benefit pension plans can be
deal killers. Some buyers don’t want to
be burdened with managing the risks
associated with historical obligations,
providing ongoing benefits that increase
the obligations over time, or administering the arrangements in light of regulatory and administrative complexity.
Other buyers may have an existing
pension plan in which they could accept
a transfer of assets and liabilities.
When deciding how to treat the defined
benefit arrangements, sellers should
evaluate both the impact on employees
as well as the financial impact. Potential
approaches for treating benefits include
changing the plan design, freezing
benefits, and retaining some or all
past benefits. A number of financial
metrics should be considered, such as
cash flows, income statement, taxation,
balance sheet, and PBGC insurance
premiums. The investment strategy for
any underlying plan assets will likely
need to be revisited post-divestiture,
as sellers may benefit from a change in
approach, such as managing a frozen
plan to an endgame through a dynamic
liability-driven strategy. The legislative and regulatory environment has
produced substantial changes in the
underlying plan economics, operations,
and reporting requirements.
Weighing all of the considerations is
complex and an appropriate balance
should be developed in light of the deal
context and seller objectives. With the
right preparation, this evaluation can help
the seller fully understand each option
and guide the negotiation strategy.
HR Innovation
21
Health and welfare benefits
Compared with retirement benefits,
the costs of health and welfare benefits
attributable to specific employees are
typically more difficult to capture.
Companies use different approaches
to allocate health and welfare benefits
costs. They sometimes allocate benefits
costs across different divisions based
on headcount or payroll without
regard to the true underlying costs of
each division. For example, the business unit being sold might employ a
younger, healthier workforce or have
lower medical plan participation than
the rest of the company. By gathering
supporting data to demonstrate lower
business unit medical costs, sellers can
highlight potential savings.
The seller should evaluate the benefits
of leveraged purchasing in determining
whether moving from seller to buyer
plans would produce incremental costs
or savings. Because of potential opportunities to increase adjusted historical
earnings, the seller should identify
these differences in developing standalone health and welfare benefits costs.
Companies that self-insure their
benefits (i.e., retain some or all of the
risk rather than paying an insurance
company to manage it), should record
reserves on the balance sheet to reflect
claims incurred but not yet paid. To
lessen the risk and deal value trade-off,
sellers should consider these obligations in light of the overall strategy for
managing unfunded obligations.
22
Executive considerations
The level of management and executive
support residing in the business unit
being sold varies for each divestiture.
Executive costs will reduce pro forma
earnings for any corporate positions
where the parent company provides
management oversight. To the extent
those executives are not transferring
with the business, their costs can be
backed out of historical and projected
costs. Also, given potential overlap with
existing executives, strategic buyers
will often consider severing some or all
of the management team.
A seller should review existing plans
and programs along with individual
employment agreements to identify any
accelerated payments the divestiture
might trigger. Examples include severance or settlement of deferred compensation balances. Buyers will typically
reduce purchase price to the extent they
are required to absorb these changein-control payments. In addition, the
sellers should review equity plans for
any accelerated vesting of awards or
accelerated payout that might result
from the divestiture.
Depending on its nature and size, the
divestiture may trigger potential loss
of tax deductions for the company and
excise taxes for individuals. These
triggers depend on the extent to
which payments from the divestiture
(parachute payments) exceed certain
thresholds, based on each individual’s
historical wages.
Depending on its nature and size, the
divestiture may trigger potential loss
of tax deductions for the company and
excise taxes for individuals.
HR Innovation
23
The seller will need to determine who will pay
the retention bonuses and, to the extent the
buyer is responsible, provide strong supporting
rationale for the payment structure. Designing
an effective plan can optimize results for both
buyer and seller.
The seller should analyze payments and
consider the level of payouts relative to
these thresholds to determine whether a
cutback in payments to avoid adverse tax
consequences or a gross-up to executives
for excise taxes would be appropriate.
Many buyers will reduce their bids to the
extent any gross-up payments become
due, so the seller will need to weigh
keeping the executives whole with the
impact on the overall divestiture.
Retention of key talent
Designing an effective retention
strategy can increase purchase price.
Sellers should consider whether the
retention strategy will benefit just the
seller by keeping key employees focused
until closing or if the strategy will also
benefit the buyer and effectively retain
key talent post-closing.
24
If transaction bonuses are paid at closing
to reward executives on the divestiture,
this likely will provide minimal value to
the buyer, and a second retention plan
may need to be funded by the buyer,
out of the purchase price. However, if
payments are delayed for six months
or one year, or are provided based on
certain performance metrics such as the
achievement of certain synergy levels,
this can provide value to the buyer by
incentivizing them to transition the business to the buyer successfully.
The seller will need to determine who
will pay the retention bonuses and,
to the extent the buyer is responsible,
provide strong supporting rationale for
the payment structure. Designing an
effective plan can optimize results for
both buyer and seller.
HR infrastructure
Moving a business unit from a large,
complex, multi-national corporation to
a stand-alone operation can result in
significant efficiencies. The stand-alone
operation could require less infrastructure, simpler systems and processes,
and a more nimble, agile company
post-divestiture. HR has an opportunity
to highlight this for potential buyers,
and help quantify the potential upside
in ongoing costs. HR departments that
build this into their approach are typically brought into the divestiture earlier
in the process while being provided
the opportunity to influence the strategic direction of the deal. Sellers can
help demonstrate potential upside by
providing buyers with data comparing
historically allocated payroll, human
resources information system (HRIS),
and other HR infrastructure costs as
compared with estimated costs on a
stand-alone basis.
To the extent a transition services
agreement (TSA) will be required for
an interim period post-closing, these
costs should also be factored in. Sellers
will need to develop a pricing strategy
and overall approach. More flexibility
in TSA support may increase the pool
of bidders as well as shorten the timeline to closing.
buyer may need to augment staff with
temporary or contract workers until the
business is fully operational.
The buyer will typically factor these onetime costs into the deal price. The seller
therefore should consider the potential
benefits of incurring some or all of the
one-time costs prior to sale—to the
extent opportunities to implement the
changes efficiently exist and/or the pool
of potential buyers is limited to financial
rather than strategic buyers.
Metrics matter
If you have designs on boosting deal
value, take a financially focused
view of the business unit that’s being
divested. Incremental costs, one-time
costs, unfunded obligations, labor and
benefits costs, executive support, and
operational structure can all affect
your deal and its potential to deliver
the results you desire. By strategically
considering each relevant component at
the business unit level, HR can enhance
the efficiency of the process; make
smart, strategic talent decisions; keep
the buyer well informed; and boost
transaction value.
One-time costs can be substantial for a
financial buyer, given the level of effort
to implement payroll and HRIS systems.
So sellers should give appropriate attention to this area. For example, outside
consultants may need to be hired to
implement new HRIS systems. The
HR Innovation
25
About PwC’s Human Resource Services (HRS)
As a leading provider of HR consulting services, PwC’s Human Resource Services’ global network of 6,000 HR practitioners
in over 150 countries, brings together a broad range of professionals working in the human resource arena—retirement,
health & welfare, total compensation, HR strategy and operations, regulatory compliance, workforce planning, talent
management, and global mobility—affording our clients a tremendous breadth and depth of expertise, both locally and
globally to effectively address the issues they face.
PwC is differentiated from its competitors by its ability to combine top-tier HR consulting expertise with the tax, accounting
and financial analytics expertise that have become critical aspects of HR programs.
PwC’s Human Resource Services practice can assist you in improving your performance across all aspects of the HR and
human capital spectrum through technical excellence, thought leadership and innovation around five core critical HR
issues: reward effectiveness and efficiency; risk management, regulatory and compliance; HR and workforce effectiveness;
transaction effectiveness; and global mobility.
To discuss how we can help you address your critical HR issues, please contact us.
Ed Boswell
Principal
US Leader, People and Change
(617) 530-7504
[email protected]
Peter Clarke
Principal
Global Leader, International Assignment Services
(203) 539-3826
[email protected]
Nadirah Ibrahim
(617) 530-5169
[email protected]
Teresa Yannacone
(267) 330-1377
[email protected]
Please visit our website at www.pwc.com/us/hrs
or scan this QR code:
Sushil Ahuja
(214) 754-5288
[email protected]
Eric Wheeler
(312) 298-2523
[email protected]
Hector Mislavsky
(646) 471-5135
[email protected]
Jim Dell
(415) 498-6090
[email protected]
Scott Olsen
Principal
US Leader, Human Resource Services
(646) 471-0651
[email protected]
HR Innovation Contributors
Sarah Tunku Mu’Tamir
(646) 471-2343
[email protected]
26
www.pwc.com/us/hrs
This publication is printed on Mohawk Options 100PC.
It is a Forest Stewardship Council™ (FSC®) certified
stock using 100% post consumer waste (PCW) fiber
and manufactured with renewable, non-polluting,
wind-generated electricity.
© 2012 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC refers to the US member firm, and may sometimes refer to the PwC
network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details.
This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. PwC US helps organizations and
individuals create the value they’re looking for. We’re a member of the PwC network of firms with 169,000 people in more than 158 countries. We’re committed to delivering
quality in assurance, tax and advisory services. Tell us what matters to you and find out more by visiting us at www.pwc.com/us. NY-13-0118