Originally published in American City Business Journals

By Paula Hendrickson and Eileen Shaw

What is a business worth? Whatever someone is willing to pay. But like many old sayings, the answer is not always correct.

Consider someone who purchases a business not knowing it has underfunded pension liabilities.

Compliance with retirement plan regulations in general — and specifically ERISA (the Employee Retirement Income Security Act) — is one of the most vexing areas of business valuation and sometimes a mergers-and-acquisitions deal killer.

What are some of the things that can go wrong? How about something as mundane as forgetting to file important paperwork, such as an IRS Form 5500? It’s easy to forget, as no taxes are due with the form; it’s just informational. But the penalties are significant for companies that fail to file.

Keep in mind, too, that most potential buyers will ask to see Form 5500 filings because the documents could uncover failure to make required retirement plan contributions. Yes, sophisticated acquirers are aware of the risks of an unfunded retirement liability and will discover such issues when they perform their due diligence (and will probably also ask that the plan be terminated before the deal closes). But those who are new to buying a business might not know to check.

Another potential source of trouble: What if the retirement plan has high fees, has not been benchmarked, has inappropriate investment options or has other ERISA risks? Well, the buyer could inherit litigation risks down the road, even if unaware of the problems. And, of course, they will be required to fix any issues, complete with penalties and interest.

Here are a just few other areas a potential buyer should examine:

Roles and Responsibilities: Who are the fiduciaries of the retirement plan? Have they received any fiduciary training? Have they documented their decisions related to the plan oversight?

Investments: Is there a written Investment Policy Statement guiding the selection and ongoing monitoring of the investment options offered in the plan? Does the IPS include the identity of each fiduciary and service provider, as well as investment objectives, goals, classes and styles? Does it require ongoing investment and investment manager reviews periodically? Does it provide an overview of employee education and advice to assist participants in making educated and informed decisions on investments?

Monitoring: Have there been regular plan reviews of any outside experts and service providers to make sure that the plan’s service and performance standards are being met? Are there any inherent conflicts existing that may impact the objectivity of the advice received? Have all reviews and decisions been properly documented?

Communications: Have there been regular meetings of the retirement committee and plan fiduciaries? What communication on investments and plan features have been provided to plan participants? Have these actions been documented?

Compliance: Has the plan passed all the annual nondiscrimination tests? Were all participants who met eligibility provided with the information and opportunity to enroll in the plan? Is the fiduciary bond adequate? Has the plan been administered in accordance with the terms of the plan document?

It’s a ton of work. These aren’t easy problems to protect against or resolve. Most retirement plans have some type of compliance issue. Ask any auditor at the U.S. Department of Labor.

Moreover, if you intend to sell your company, it is critical to audit the plan operation and fiduciary oversight for three to five years ahead of your anticipated sale date. It is best to complete a compliance review annually and record the findings.

Looking for a shortcut? Remember another old saying: The person who is his or her own lawyer has a fool for a client. The same holds true for companies engaging in the sale or purchase of a business, especially if there is a retirement plan involved.

ERISA is very complex area of law. It is wise to engage an ERISA attorney to provide guidance and counsel on any potential risks that an employee benefit plan may cause.

Paula Hendrickson is a senior vice president and director of retirement consulting services at First Western Trust in Denver. She has more 30 years of experience in retirement planning. Eileen Shaw is an ERISA consultant for First Western Trust in Denver, where she is responsible for creating qualified retirement plans tailored to clients’ unique needs.