A total rewards program can unlock the full potential of your transactions, but the benefits don’t come without complexity. Here’s how — and where — total rewards can increase value across your portfolio and how to navigate this impactful strategy.
For private equity firm leaders, decisions in the deal landscape aren’t often made with the benefit of excess time or resources. Considerations are numerous, stakes are high, and incorporating unconventional strategies into your investment thesis might seem like an effort with little payoff. That’s why it’s crucial to understand what can have the biggest impact on the long-term success of your transaction — and how to make a value-unlocking strategy repeatable throughout your portfolio.
Private equity leaders increasingly recognize the value a comprehensive and competitive total rewards strategy can have for any acquisition. A well-designed total rewards program can improve talent retention, performance, and profitability. Each phase of the transaction life cycle presents new opportunities and challenges. Here are the risks you need to be aware of, strategies for overcoming them, and what success could mean for future transactions.
But first, let’s define total rewards.
What is total rewards?
“Total rewards” refers to the full scope of a company’s compensation and benefits structure, which often includes base compensation, bonuses or other incentive-based payments, healthcare, retirement plans, fringe benefits and perquisites, paid time off, professional development opportunities, and work/life balance initiatives. A well-crafted total rewards program can attract top talent, boost employee retention and engagement, and provide a competitive edge in a tight labor market. When employees are appreciated and rewarded for their good work, the individual’s performance and the company’s performance are elevated. However, many smaller companies that make for appealing acquisition targets have compensation and benefits programs that are outdated, out of compliance, or poorly structured and expensive to maintain. While due diligence can and should uncover many of these issues, it might not capture all, which can lead to problems that differ in severity. This makes the acquisition phase arguably the most important when evaluating your target’s total rewards strategy.
Total rewards in the acquisition phase
Reviewing total rewards during the acquisition phase will lead to increased performance later in the transaction life cycle. Depending on the target’s size, history, and complexity, specific risks associated with compensation, benefits, and incentives can have widespread ramifications on the entire life cycle. When conducting due diligence, some key areas to evaluate include:
401(k) plans. 401(k) plans are common, but there are various ways to design the plan. If the 401(k) plan isn’t comparable to competitors, it can lead to difficulties with recruiting and retention.
Pension plans. Although far less common than 401(k) plans, pension plans face the same regulatory and compliance risks but with added financial burdens. They’re expensive to maintain, particularly in a volatile market, and underfunded or frozen pension plans can incur significant unexpected costs.
Executive compensation plans. Executive leadership is vital for business success, but their compensation plans often involve equity or ownership, making them difficult to replace and risking the alienation of key value drivers.
Employee stock ownership plans (ESOPs). As private equity firms invest in new industries like construction and professional services, they may encounter ESOPs. An ESOP will make any transaction more complex, with increased costs, regulatory scrutiny, and deal structuring. Additionally, acquisitions of ESOPs can negatively impact retention, leading to significant cultural shifts and high turnover.
Depending on the target’s size, history, and complexity, specific risks associated with compensation, benefits, and incentives can have widespread ramifications on the entire life cycle.
Once due diligence is complete, if you decide to move forward with the acquisition, here are some potential solutions:
Enlist a third party to perform a detailed compliance assessment of the 401(k) plan and uncover any existing compliance issues. An effective compliance assessment will also provide a strategy for remediation and recommendations for improvement.
Settle all pension plan benefits and move to a simplified, well-structured 401(k) plan, which offers greater flexibility.
Implement different forms of employee and executive compensation, such as bonuses, stock appreciation, or phantom stock, to maintain investment and morale.
Depending on the overall shape and structure of the compensation and benefits you want to offer, there are other incentives you may want to consider that can contribute to staff engagement and retention and create long-term value.
Total rewards in the value creation phase
The value creation phase provides new opportunities to evaluate how your total rewards program satisfies employee expectations and contributes to cultural and operational excellence. In many family-owned or closely held businesses, incentives like bonuses and compensation increases can be determined arbitrarily and out of step with trends in the market. This can negatively affect employee engagement and contribute to cultural defects like high turnover, complacency, and misalignment with company goals.
Different forms of total rewards based on performance and other fringe benefits can engage employees in the company's success and motivate high achievement — and stronger rewards often lead to stronger results. Here are a few you should consider:
Bonuses and compensation increases linked to performance and other employee recognition programs.
Health and wellness programs and work/life balance initiatives.
Career development opportunities, such as ongoing professional education, certifications, and tuition reimbursement.
Involving employees in these processes through targeted surveys, focus groups, and one-on-one interviews can help determine overall satisfaction, identify perceived gaps, alleviate existing strains, and resolve unmet needs. Using feedback from the internal surveys as well as market knowledge from external sources, a private equity group can target its investments in total rewards programs to increase the worth of the business through enhanced employee engagement and improved retention. With a continued focus on total rewards throughout the value creation phase, you can create a high-performance environment and strong culture. As you move toward the exit phase and prepare to sell, these factors can positively impact the business’s value. For more insights on total rewards in the value creation phase, visit this article where our experts take a deep dive on the topic.
Total rewards in the exit phase
The exit phase is where all your careful planning pays off. A deliberate, comprehensive total rewards program can increase satisfaction and retention, encourage higher productivity, and develop employee skills to create a functional and profitable business, making it more appealing to potential buyers. But it’s critical to pause here and ensure your total rewards program is administratively sound and fully compliant before the sale.
Undergoing an employee benefit plan compliance assessment can provide peace of mind to your investors and ensure your employee rewards solutions withstand regulatory scrutiny. Doing so will eliminate potential roadblocks during due diligence and facilitate a smooth and speedy transaction. Buyers will appreciate acquiring an organization where employees feel valued and actively contribute to the business’s success.
Total rewards — if you’re not thinking about it, you should be
If you’re not thinking about total rewards in relation to your portfolio value, you should be. Once developed and implemented, a strong total rewards strategy can be templated and broadly applied, increasing the value of subsequent transactions and your overall portfolio. By adopting a strategic approach to total rewards, you can drive value creation, enhance profitability, and achieve successful exits, ultimately securing the long-term success of your investments.
Once developed and implemented, a strong total rewards strategy can be templated and broadly applied, increasing the value of subsequent transactions and your overall portfolio.
