Why the Seller’s 401(k) Plan Matters in a Business Acquisition
In the long list of considerations when buying a company, a commonly overlooked item is the seller’s retirement plan. While the 401(k) plan may not be the first thing on anyone’s mind during the purchase of a business, understanding what happens to that plan—and how the type of transaction plays a role—is critical. Most importantly, the type of acquisition will determine how the seller’s 401(k) plan is managed.
Asset Sale vs. Stock Sale: Why It Matters for Retirement Plans
In an asset sale, the buyer is acquiring specified things from the seller’s business, such as inventory, equipment, or property. The original owners of that business still own the entity, which may or may not close after the assets are sold. Since that entity remains intact, the original owners are responsible for any qualified plan they sponsor. In other words, the buyer doesn’t need to do anything with that plan.
A stock sale, on the other hand, means the buyer purchases ownership of the entity. Whether this is a stand-alone company or a subsidiary of another company, the buyer in a stock sale acquires all assets and liabilities of that company—including the 401(k) plan. So, while the seller in an asset sale continues sponsorship of their plan after the sale, the buyer in a stock sale automatically assumes responsibility for the seller’s plan.
What Are the Buyer’s Options in a Stock Sale?
The options and timing will depend on the purchase agreement, but the three options are as follows:
1. Terminate the Seller’s Plan
If the buyer doesn’t want to assume ownership of the plan, they must require the seller to formally terminate the plan prior to the date of sale. This means, at minimum, that an amendment should be prepared to terminate the plan prior to the transaction. Once the sale has gone through, the buyer in a stock sale becomes the plan sponsor and assumes responsibility for that plan, including its operation prior to the sale.
2. Continue or Freeze the Seller’s Plan
Rather than terminating, the buyer can continue the seller’s retirement plan as the new owner and plan sponsor. They will need to consider whether the plan should continue, be frozen, or be merged into their own.
3. Merge the Seller’s Plan into the Buyer’s Plan
Merging the seller’s plan into the buyer’s plan may seem like an efficient way to consolidate retirement benefits, but it comes with potential pitfalls. The biggest is that any errors in the seller’s plan (such as administrative mistakes or compliance issues) are inherited by the buyer and can taint the buyer’s plan when the plans are merged.
Furthermore, the surviving plan cannot reduce or eliminate benefits as part of the merger. Therefore, it’s essential to complete an analysis of each plan’s provisions before the sale to determine how to proceed.
When Acquiring a Company, Don’t Overlook the Seller’s 401(k) Plan
Whether it’s an asset sale or stock sale, the buyer and seller must both understand how the transaction will affect their plans. Due diligence can help prevent costly post-transaction issues and liabilities.
For more information about acquisitions, please reach out to your Blue Ridge Associates consultant.
