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PRINT THIS PAGE Private equity investment in companies with a defined pension scheme deficit plummets
27/09/2006. Source:Grant Thornton Corporate Finance.
Private equity investors are becoming increasingly cautious about investing in companies with defined pension deficits, according to a survey of mid-market private equity investors carried out by Grant Thornton Corporate Finance. According to the results of the survey, over the past year 37% of private equity investors completed a deal with a company with a defined pension deficit. This is in stark contrast to the corresponding period in 2005 when all VCs responding to the same Grant Thornton survey admitted to completing at least one deal with a company with a defined pension deficit during the previous twelve months.
However, while VCs are less likely to complete such transactions, the survey revealed that over six out of ten VCs are still considering affected businesses for a potential investment.
Mat Bhagrath, partner at Grant Thornton Corporate Finance said: "Following the introduction of new accounting rules, pension fund deficits have risen to the top of the corporate agenda. It is hardly surprising that private equity investors have become increasingly cautious about investing in companies with a defined pension shortfall.
Few VCs can take a long term view when making an investment. They are typically looking for a return within a three to five year timeframe and this may be deemed too short to bolster a significantly underperforming pension fund."
Looking at the results in greater detail, private equity investors' exposure to pension liabilities appears relatively limited. Asked what proportion of their portfolio had significant pension deficits, over half (58%) claimed to have no deficits at all (48% in Q1 05), whilst 92% (86% in Q1 05) claimed to have significant pension shortfalls in 30% or less of their portfolio.
The remaining 8% cited pension liabilities for a higher proportion of their portfolio - the highest being between 60% and 70% (of their total investments), although this was only the case for 1% of the VCs surveyed.
These findings come in anticipation of the introduction of the substantial Pension Protection Fund (PPF) risk based levy. The information about the status of a final salary scheme registered with the Pensions Regulator as at 31 March 2006, in conjunction with an "Insolvency Score" devised by Dun & Bradstreet (to indicate the likelihood of the insolvency of the sponsoring employer), will be used to calculate the risk based element of the levy. This levy is payable for the year commencing 6 April 2006.
Bhagrath continued: "It appears that VCs are increasingly looking for acquisition targets without the 'hassle' of pension shortfalls or looking to divest, where possible of those companies in their portfolio with a pension liability. New accounting standards have brought the pensions issue to the forefront of investors' minds. In particular, FRS 17 has reinforced the risk factors involved when investing in a company with a pensions shortfall."
When asked what they were planning on doing with those companies within their portfolio that have a pension shortfall, the majority of private equity investors (60%) said that they would alter the benefit or contribution structure of the pension scheme. Almost one fifth of VCs (17%) claimed that they would plug the shortfall with a one off financial contribution, whilst 13% said they would sell the company and the remainder (10%) said they would seek insurance.
He continued: "Interestingly only a small minority of private equity houses are looking to dispose of those companies within their portfolio which are subject to pension shortfalls. This reflects their concern over the likelihood of imminent realisations and the prospect of managing the deficit over a medium term timeframe as well as achieving a better ultimate return on investment."
"In my opinion, the return of trade buyers who can take a longer term view and can present a stronger covenant to pension trustees makes them better suited to buy companies with defined pension scheme deficits," concluded Bhagrath.
The Grant Thornton Corporate Finance survey was conducted during February 2006 amongst 100 mid-market private equity investors who are typically involved in deal values of between £5m and £200m
Grant Thornton is a corporate finance firm dedicated to serving the needs of middle-market companies. For more information please visit www.grant-thornton.co.uk
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