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Incentive Considerations in M&A Transactions

A company that is acquiring or selling a business needs to evaluate the potential advantages and liabilities of incentives already in place, as well as opportunities for future incentives.

Q4 2018
The use of economic development incentives by state and local governments to attract new investment and employment opportunities has increased significantly over the past 10 to 15 years. During this time, the types of businesses and transactions eligible to receive economic development incentives have been liberally expanded. As a result, the evaluation of the risks and potential benefits from economic development incentives are important items to be considered as part of any due diligence review in the purchase or sale of a business.

In general, governmental entities offer economic development incentives that fall within four broad categories: (1) training assistance; (2) tax credits, abatements or exemptions based on employment growth or new capital investment; (3) financial assistance in constructing or improving public infrastructure; and (4) cash grants or loans based on discretionary incentives, tax increment financing or similar programs.

Each of these incentives can provide potential advantages and pitfalls when acquiring or selling a business. When evaluating a potential acquisition, the acquirer should gain a full understanding of all prior incentive agreements entered into by the target. If there are none, the acquirer should evaluate the impacts of the acquisition on the combined company and its long-range prospects in order to determine if incentives may be available to support the acquirer’s post-acquisition plans and long-term site location decisions for the business.

Existing Incentives as an Asset
If a company has existing incentive agreements in place from a prior site selection or expansion project, a thorough review of the programs approved and agreements entered into is critical to understanding if there may be an opportunity to continue to claim incentive benefits post-acquisition. Many states and communities are willing to assign and/or restructure incentive agreements in a sale transaction if the outcome of the sale will be positive or neutral as compared to the original project projections.

Chad Sweeney, senior principal for Ginovus, provides location modeling, site selection, and advice on structuring economic development incentive agreements for clients throughout North America. Sweeney has closed transactions resulting in over $1.1 billion of capital investment and an estimated 7,700 new jobs. Before joining Ginovus, he served on the leadership team of the Indiana Economic Development Corporation (IEDC), where he held the roles of EVP, CFO, and General Counsel. He represented Indiana in structuring and negotiating incentives for more than 700 companies, including Nestle, Honda, and Amazon. Sweeney’s depth of experience gives him the knowledge and expertise to understand projects ranging from complex corporate transactions to the needs of startup companies.
As a result, if the company is currently receiving benefits under existing incentive arrangements, it is possible for the acquirer to continue to benefit from the incentives post-acquisition, and to even increase the amount being earned if post-acquisition growth or investment is contemplated. However, timing can be a critical component to a successful transition of any incentive benefits. It is important to negotiate any assignment of the incentive benefits prior to closing and to understand how post-acquisition plans may impact (positively or negatively) the underlying incentive value.

In the case of an acquisition transaction structured as an asset sale, most governmental entities allow for incentive agreements and their related benefits to be assigned to the acquirer. However, care should be taken to ensure the assignment is done timely and in the appropriate manner, as many incentive agreements have specific notice and approval processes that must be followed. In addition, the assignment may result in an obligation for the acquirer to assume potential repayment obligations resulting from incentives claimed by the target pre-acquisition. These potential liabilities should be weighed against the anticipated future value of the incentives in determining whether an assignment of the incentive agreements should be pursued.

Existing Incentives as a Liability
Therefore, in addition to assessing existing incentives for future benefits, incentive agreements should be reviewed for potential future liabilities. Incentive agreements often have relatively long terms. It is not uncommon for the benefits under incentive programs to be claimed over a period of 10 years or more. In addition, many incentive agreements (or the underlying enabling legislation) often have requirements for a company to maintain operations and headcount at a particular location for a period of time extending beyond the period during which incentives can be claimed. These provisions can often be overlooked, since the company may no longer be eligible to claim incentive benefits.

Due to the length of the incentive terms and the post-incentive commitments, repayment obligations can often extend for more than 10 years, and in some cases up to 20 years, from the date the incentive was originally awarded. This creates the potential for significant continuing liability associated with a transaction that may have been all but forgotten by the target company. Actions such as relocation of operations, closure of a facility or a significant reduction in headcount could result in a requirement to repay previously earned incentives, including in some cases with the addition of penalties and interest. A full understanding of these potential liabilities is critically important in order to negotiate an appropriate allocation of risk as part of the purchase transaction.

The evaluation of the risks and potential benefits from economic development incentives are important items to be considered as part of any due diligence review in the purchase or sale of a business. Incentives as an Opportunity
When approaching an acquisition, incentive opportunities should be evaluated even if the target company does not have any existing incentive arrangements. Acquisitions often involve a review of existing operations and a thorough analysis of the most advantageous location for continuing operations, including the combination of company headquarters or support operations and, in some cases, consolidation of operational capacity. As with other site selection decisions, incentive opportunities should be considered as part of this overall analysis. Questions to consider are whether the acquisition will result in new capital investment or employment growth, or the retention of a significant number of employment positions otherwise at risk. If so, there may be opportunities to pursue incentives in advance of closing to offset the initial costs of the acquisition and to reduce ongoing, post-acquisition operating costs.

Even if capacity consolidation is being considered, such as in the case of a strategic acquisition, there may still be incentive opportunities to consider. While consolidation activities may result in an overall decrease in employment, they often result in an increase at the facility into which the consolidation occurs. In such a case, economic development incentives may be available to support the facility that is the beneficiary of the new capital investment and/or employment positions, helping to offset the costs of consolidation and relocation of assets and employment.

An understanding of the benefits and potential liabilities of incentives programs is an important component to understanding the overall risks and opportunities in an acquisition or sale transaction. This understanding and analysis can provide meaningful value to the overall acquisition transaction, while at the same time guarding against any unexpected post-closing surprises.