Prepare and Prevent Common Due Diligence Issues in Health IT Transactions: Human Resources Considerations (Part 3 of 6)

January 11, 2018

Over the next few months, HGP is publishing a 6-part research series covering a range of due diligence issues that are common to Health IT and Services transactions.  The 6 sections cover: Accounting and Tax, Legal, Human Resources, Operations, Intellectual Property, and Technology.  In today’s edition, we are covering the Human Resources topics.

Employment Agreements

Several minor issues may arise in relation to employment agreements.  Any verbal agreements between employer and employee must be put in writing.  Employment agreements must contain assignment of intellectual property language to ensure the employer has title to the developed IP.  Tax matters may arise in relation to guaranteed payments versus salaries and withholdings (especially when operating in multiple states).  The most significant issues are option design and transaction bonuses, which are discussed in more detail later in this section.


Key Employee Retention

High employee attrition is a red flag for potential acquirers.  Attrition at the executive level may also be a red flag.  Companies should take executive turnover under consideration when evaluating the timing of a transaction.  Furthermore, the transaction process itself should be designed around the objectives of the executive team and their personal plans to remain with or depart from the company.  Finally, most buyers will want to design a transaction with incentives to retain employees.  If a seller can structure employee incentives that benefit a buyer following a transaction, the seller should seize this opportunity to further this objective on behalf of a buyer.


Employee Disputes

Disputes between employee and employer are unfortunately common, however, so long as these disputes are not a red flag for greater issues, buyers are somewhat accustomed to handling these matters through indemnification or getting to a settlement pre-closing.


Benefit Plan Design

A company should ensure compliance with the many regulations (including ERISA) that govern benefits administration.  Benefit issues also arise when there is a large discrepancy between seller and buyer benefit plans:

1) Seller benefits are superior to buyer benefits. While this may result in a synergy for the buyer, it also means that the seller’s employees will be stepping into a less generous benefit structure, which may equate to an effective pay cut. Buyers can address this by translating the lower benefit cost into salary increases.

2) Seller benefits are inferior to buyer benefits. When this occurs, buyers may have to factor the higher benefit cost into their purchase price, thus reducing the effective profit of the selling business.


Employee Compensation vs. Market Rates

In transactions that involve a larger acquirer buying a smaller company, the most typical situation is one where the smaller company’s employees receive below market salaries.  To ensure employee retention, a buyer may need to adjust these salaries upward, thus resulting in a negative synergy.  Negative synergies such as salaries and benefits are often the “price of doing transactions”, and while a buyer may try to use this against a seller in a deal negotiation, this may or may not impact the purchase price.


Option Design and Transaction Bonuses

If employees have an economic participation in a sale transaction, either through options or transaction bonuses, terms must be accurately documented with clear and transparent terms and conditions.  This documentation should be completed with advice from legal and tax counsel to ensure that option design and transaction payouts do not create any tax or indemnity issues for the seller.  A second matter is triggering 280G excess payments, known as a “golden parachute.”  280G is triggered when the amount of the compensation-related payment at the time of transaction for an individual earning over $115K equals or exceeds three times the disqualified individual’s average annual compensation from the corporation or its related entities for the five years preceding the year of the change in control.  A penalty in the form of a 20% excise tax is applied to the excess payment.