In a disruptive future, with business models under pressure – could your scheme outlast or outgrow your business?
We live in an age of unprecedented change. Most people have seen the impact on the economy of disruptive businesses such as Amazon, Airbnb and Uber. However, just how widespread this change is likely to be was highlighted by KPMG’s Global CEO Outlook survey of 2016 where 65% of Chief Executives expressed concerns that new entrants are disrupting their business models.
This presents a significant challenge to the many businesses who sponsor defined benefit pension schemes, where promises extend for many decades into the future. For corporate sponsors, the key question is how do you plan to ensure that your pension scheme doesn’t outlast or outgrow your business?
I think the first part is looking at your current pension strategy and how this aligns with your existing corporate objectives. In my experience, far too many organisations have a pension strategy based around features of the scheme: such as the proportion of members who are retired or the balance of contributions to benefit payments, rather than the future plans of the business.
No two businesses have the same corporate strategy but there are often common themes that can be drawn from different ownership structures. A good illustration is in Private Equity where there is likely to be a clear timeline for an investor to sell their stake and ‘exit’ the business. For shareholders in this environment the pension strategy is clear, think about the exit, the universe of potential buyers and the price reduction they will apply for the pension scheme. Then set an approach which aims to reduce both the size of the price reduction and the risk that it will be higher than expected.
An interesting corollary is that despite this strategic clarity, in my experience Private Equity houses often take a more negative view of defined benefit pension schemes when buying businesses compared to other investors. I guess this is because even with the best pension strategy it is hard to escape the fact over a 3 - 5 year period, there is a fairly significant risk of a material defined pension scheme having a greater impact on your businesses valuation than you had hoped.
Finding the right pension strategy in a PLC, Owner Managed Business or Family Business can be more involved due to the complex goals of different stakeholders. However, for many PLCs there will be a need to manage analysts and dividend expectations, Family Businesses will have succession events and Owner Managed Businesses need to provide sufficient income to their shareholders. All of these aims combined with usual day-to-day needs of companies to make capital investment can be carefully pulled together to build a pension strategy that finds the right balance between the stakeholders.
Once a business has a strong pension strategy in place then the next question is how should that strategy respond to disruption? The first piece is to try and identify the beginnings of disruption as early as possible. Secondly, to start looking at what this means for your business objectives. Perhaps there will be the need for refinancing, a change in ownership or a refocus into different sectors? Then, to determine the impact of these actions on your pension scheme and work out what this implies both for your pension strategy and wider corporate strategy.
As an example, a historic listed business with a significant defined benefit scheme was disrupted by market entrants. It faced significant decline in turnover, particularly in its ability to make profits. It needed investment to grow into new markets and its reduced scale meant the overheads of maintaining a listing were draining important resources.
The business managed to complete a Management Buyout with additional bank funding being offset by extra pension scheme security and the promise of greater pension scheme contributions in certain positive scenarios. The management is now focussed on a medium-term exit (in around 5 - 10 years) and is in the process of completing a targeted program of liability management and insurance transactions to reduce the impact of the pension scheme on this deal.
What do you do if the disruption is too severe and the pension scheme is too big to be afforded by the business? Firstly, having supported a number of businesses in this position, I recognise what a painful and emotional time this can be for all involved. However, even in these dark times a plan to manage the situation is essential. There are processes available such as Pension Protection Fund compromises and even pre-pack administrations which could allow a trading business to continue. The earlier you start to examine these options and determine which, if any, could work for you, the greater the chance jobs can be saved and a better return to the pension scheme achieved.
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