Executives involved in M&A transitions have many competing priorities. Adding economic development incentives to the list may be challenging, but the potential upside of doing so – or downside of not doing so – should not be overlooked.
BLS & Co. has advised a number of clients exploring, transacting or integrating an acquisition. We have found that each transaction has its own unique circumstances, but there is a distinctive set of recurring issues. Following is a review of these issues, and how companies can optimize their incentives position, avoid pay-back risks, and add value to the bottom line.
How do economic development incentives create value?
Economic development incentives are given by state and local governments in exchange for corporate commitments to create/retain jobs and invest in a given community. Incentives take many forms, including grants, tax abatements and credits, recruitment/training assistance, and infrastructure improvements. Utilities also have tools available to attract and grow companies.
Mergers and acquisitions cause companies to shift their location strategy, and the economic development community is alert to these potential changes. By way of illustration, BLS & Co. client Newell Brands, successor entity to the Newell Rubbermaid - Jarden Corporation combination, attracted the interest of locations seeking to benefit from the anticipated portfolio realignment:
Do the entities have existing incentive contracts?
If so, the buyer/successor will need to understand the potential benefits and the accompanying obligations, which may include maintenance of business operations, employment counts, wage levels and investment. Failure to fulfill these commitments can result in termination or recapture of benefits and, potentially, financial penalties.
Even in cases where the financial impact of non-compliance is immaterial, steps may be needed to preserve positive community relations.
In most cases the existing contract can be assigned to the successor entity/new owner if proactively addressed with the public-sector entity.
Some situations may allow for renegotiation of existing incentive agreements. The likelihood of successful renegotiation increases when locations are vying to host the new/successor organization and/or the company is a victim of widespread economic disruption either within its industry or more broadly across the economy as a whole (e.g., the Great Recession).
Will existing employees of the acquired company count as new employees of the successor entity?
We have generally found that, in the event an acquisition occurs during the performance period of an existing incentives agreement, any “acquired” in-state employees will not be designated “new employees” for purposes of meeting job-creation obligations. However, in some states, particularly when there is net employment growth anticipated, the existing acquired jobs may be eligible for retention incentives if there are competing location alternatives for those jobs.
How and when do you set the successor entity’s baseline against which new job growth will be measured?
The concept of “baseline employment” references the number of employees (frequently on a statewide basis) designated as having “pre-dated” the incentive agreement. Baselines are generally established as of a date that coincides with the awards process itself, for example the application date, the approval date or the agreement date, and with the expectation that 1) the company’s employment will not drop below the baseline, and 2) only net job growth above the baseline will count toward incentive benefits.
The enabling legislation and related regulations governing most incentive programs are ill-equipped to address baselines in the context of corporate transition, when an employee may work for one legal entity one day, and another the next. There is typically little precedence for answering such questions as, which jobs are included in the baseline? Those of the acquiring company? The acquired? Both companies? Will part-time employees be counted? It’s not uncommon in the wake of a merger for the new parent company to move contract employees onto the direct payroll, or vice versa. How might that affect the baseline?
The underlying point is that the details concerning the establishment of the baseline need to be fully explored and understood, as they will have a direct impact on the value of the incentives agreement.
How can a company in transition be expected to reliably forecast job creation and investment?
Even the best executive teams can’t predict the future. Nevertheless, most incentive programs require companies to commit to the creation of an agreed-upon number of jobs over an extended term.
While the company’s strategic growth plan forms the foundation of employment and investment targets, the targets must be sensitive to the non-compliance remedies established by the program. Some incentive programs are structured to heavily penalize a missed target, necessitating a conservative estimate. Other programs offer “margins for error,” allowing for a more aggressive target.
In some instances, we find a growth strategy may not be as monolithic as it appears. That is, a later wave of growth may be dependent on a separate set of factors. That latter growth may, therefore, constitute its own distinct project, better addressed in a few years when there is greater clarity as to the timing and size of the expansion.
An initial headcount reduction may be required, followed by growth. How will this affect our incentives strategy?
This situation is not uncommon; however, despite the potential for net positive economic growth over time, job reductions put public officials in an awkward position, exposed to the potential media fallout of providing incentives to a company that recently laid off employees. Companies will need to effectively communicate to public officials the ultimate upside of the project, plus demonstrate how that message can be communicated to the media and public.
In short, incentive negotiations are always an illustration of “the devil being in the details,” but even more so during a merger or acquisition.
Tracey Hyatt Bosman is a Managing Director at Biggins Lacy Shapiro & Co., one of the largest, most highly regarded site selection and incentives advisory firms in North America. BLS & Co. helps manage the complexities associated with finding optimal locations and securing incentives to support new ventures. www.BLSstrategies.com