According to the Duff & Phelps Staffing Industry M&A Landscape, the first quarter of 2015 produced 25 staffing industry merger and acquisition (M&A) transactions, consistent with the sector’s average quarterly activity over the past three years. This indicates that staffing firms with strong growth and profit margins will continue to be highly sought after, both by strategic buyers and private equity firms.
A significant controllable component of a staffing firm’s margin profile is its state unemployment insurance (SUI) tax burden. However, because the joint federal-state unemployment system more closely resembles a social insurance program than a tax, SUI is the only employer tax where the underlying rate can be lowered with proactive engagement on the part of the employer. SUI tax rates are of particular importance in the this sector, as even small to midsize firms have sizeable payrolls that are subject to the annual taxable wage bases in each state. In addition, these tax rates are considerably affected by a staffing firm’s unemployment experience (i.e., history of employee turnover), a concept which allows firms to leverage M&A transactions in managing SUI tax rate risk.
When a staffing firm acquires an unaffiliated firm, there may be options as to how the unemployment experience effects the post-transaction SUI tax rates of the parties involved. State workforce agencies require, prohibit or allow (i.e., optional) the transfer of unemployment experience from the seller to the buyer or from the buyer to the seller (e.g., in a reverse merger), the determination of which is dependent on the movement of the internal corporate and contingent workforce.
Financial modeling allows a buyer to assess the most SUI tax efficient acquisition structure, taking into consideration other strategic objectives of the buyer. Such modeling permits the buyer to assess:
- Alternative tax-efficient structures
- Available transfer of experience options
- Effective date of revised SUI tax rates
- Post-transaction SUI tax rates and financial impacts
- Methods used to transfer SUI experience (employee specific or percent of payroll)
- Use of voluntary contributions
- Impact on joint accounts
A critical consideration in analyzing financial impacts associated with the movement of workforce is the ability to carry over wages from one employer (the seller) to another (the buyer) when an M&A transaction occurs mid-year. Opting out of a transfer of experience may preclude a buyer from being able to use the wages paid by a seller to meet the annual taxable wage base limits for SUI tax purposes. This can significantly reduce any cost-savings that may otherwise be realized. If annual taxable wage base limits are restarted, inadvertently or due to data or system limitations, buyers may be able to seek retroactive refunds where the statutes of limitations allow.
Understanding the SUI tax provisions of each taxing jurisdiction can produce significant cost-savings and prevent unintended consequences. Recognize that each set of facts and circumstances is unique, and must be specifically analyzed to produce the most advantageous results.