6th February 2018 Executive Pensions – at arm’s length?
Potential business acquisitions are subject to intense due diligence by private equity firms, but a crucial element they sometimes miss- executive pensions- could unravel their plans.
Small self-administration pension schemes were historically set up for members of senior teams at owner-managed businesses. These owner-managed specific plans enable entrepreneurs to invest their pensions in their business.
They are notoriously difficult to spot, and present challenges for investors looking to take a majority stake in, or full control of, a business. While the owners might consider the SSAS as their personal pension arrangement and not connected to the business, in reality the two are closely linked.
The SSAS is an occupational pension and one of the parties to it is the legal entity that owns the business; this means the target has powers and obligations as the scheme’s employer, just as it would if the scheme was open to the rest of the workforce.
Additionally, SSASs often enter into commercial arrangements with the underlying business, such as loans, or holding freeholds and leasing to the business. The private equity investor may find a former owner which is now his landlord, or the creditor of a lightly documented loan. At the very least, this situation could generate tricky conversations about warranty claims and earn outs.
How can a private equity firm or fund manager avoid this situation?
Potential dealmakers must establish the true details and extent of any executive pensions. Sellers may fail to disclose what they judge to be a personal arrangement through an honest lack of understanding of its connection to the business.
It is generally advisable to unwind the transactions the business has with the SSAS. Investors may fail to understand just how much power the investors have in a SSAS as the sole trustees. A “family pension” can sound a lot more ‘at arm’s length’ than it is in reality. This unwinding is usually possible as a completion deliverable, as long as a firm observes regulations around how the investments operate.
The best course of action could be to jettison the SSAS altogether. There are only two ways of getting rid of the SSAS: either changing its employer to a business the sellers are seeking to retain, or otherwise wind it up with sellers transferring their assets elsewhere.
This is rarely a completion deliverable given the time constraints. Instead, this process often takes place with a post-completion agreement, with indemnities from the seller as appropriate.
Ultimately, an executive SSAS shouldn’t destroy a deal or result in a purchase price being adjusted. But it could still prove disastrous for a business and tie the hands of private equity investors. If ignored at the investment stage, it can create real challenges for the future, with a seller often holding worrying levels of control over a business they no longer actually own.
Rosalind Connor, Partner
This article was published in Private Funds Management
The views in this article are intended for general information purposes only and should not be used as a substitute for professional advice. ARC Pensions Law and the author(s) are not responsible for any direct or indirect result arising from any reliance placed on content, including any loss, and exclude liability to the full extent. Always seek appropriate legal advice from a suitably qualified lawyer before taking, or avoiding taking, any action. If you have any questions on the points raised in the above, please do not hesitate to get in touch.