EU Pay Transparency: deal-makers should act now

In March 2023, the European Parliament adopted the EU Pay Transparency Directive (EU PTD), which mandates EU Member States to incorporate the Directive into their national laws. This landmark legislation introduces stringent requirements for pay transparency to promote gender equity. Companies with more than 100 employees in an EU country will need to comply. Compliance and reporting start as early as 2026 and 2027, respectively, depending on the size of the company. For more detailed insights into the directive, please refer to this series.

Understanding the implications of this directive is also crucial for buyers evaluating potential acquisitions in the EU as it may:

1. Impact deal valuation as future operating costs might be understated and potential back-dated payments need to be reflected
2. Increase risk of legal compliance and employee claims
3. Incur additional one-off costs if Target has not begun adoption of new standards or if the deal pushes the headcount above defined limits
4. Have other impacts such as cultural integration, impact on employee morale, and strategic alignment with overall goals
   

The stringent pay equity rules can have direct implications on the deal valuation, as well as on any associated legal and financial risks. If a target company is found to be underpaying its employees based on an equal pay analysis (for example, the EQUAL-SALARY certification, or via local audit assessments), the future cost of equalising pay should be factored into any deal valuation. To provide an example, if the target was estimated to be underpaying employees on aggregate by EUR 500k p.a.¹ then this would reduce the target business valuation by approximately EUR 5 to 7.5m assuming a deal multiple between 10 and 15.

It's not only the immediate cost of adjusting salaries that needs to be considered – there may also be back-payments required. Some countries, such as the UK and France, already have stringent requirements for back-payments, with limits of 6 years and 5 years respectively, significantly increasing the financial burden. Implementation of the EU PTD is expected to expand these requirements across Europe, increasing the associated risk. Such outstanding historic payments will obviously need to be reflected in the price of the Target – taking the same example as earlier, a pay gap of EUR 500k p.a.¹ in France would reduce target business valuation by EUR 2.5m.

Non-compliance with the directive can also lead to other significant legal liabilities, including fines and compensation claims from employees, in addition to equalising their pay. Buyers need to assess the target company's risk exposure and ensure that any potential liabilities are accounted for in the transaction.

Though compliance will only be required from June next year, we believe that acquiring companies should carry out this analysis early to protect themselves from any future shocks after the transaction has been completed. And, of course, to ensure the right price is paid for the business.

^{1 PwC's Women in Work Index highlights a significant gender pay gap across the EU overall, but there are big differences between EU countries. For example, the unadjusted gender pay gap was estimated at 18.2% in Germany compared to 4.9% in Italy in 2023. To provide some context to the pay gap used of EUR 500k, this would be applicable to a total payroll of EUR 10.2m in Italy (using the 4.9% gender pay gap) and EUR 2.7m in Germany (using the 18.2% gender pay gap).}

Compliance with the directive will involve extensive background work. Among other things, companies must conduct thorough equal pay analyses and job evaluations to group employees into appropriate job categories and recruitment processes may need to be adjusted to ensure compliance with transparency requirements. Depending on the company size it will require additional time and costs to adopt the new requirements into the HR processes and systems. This is challenging for any company, but even more so for buyers with little or no EU presence, who may lack the necessary expertise and systems to meet these requirements.

Additional compliance obligations may be triggered if acquiring a company pushes the buyer over certain thresholds. For example, if a company with 240 employees acquires a target with 20 employees in Germany, the 250 employee threshold would be exceeded, requiring gender pay gap reporting every year rather than every three years.

Furthermore, a more thorough due diligence process will be required in the future, with the extra requirement to scrutinise the target company's compliance with the EU PTD.

While the focus is often, understandably, on the financial, compliance and legal implications, buyers should consider other potential consequences such as cultural integration, impact on employee morale and strategic alignment with their overall goals. Addressing pay disparities and ensuring compliance with the directive can have a positive impact on employee morale and retention if done correctly, but it may also necessitate changes in the target company's culture and operational processes.

The EU PTD presents both challenges and opportunities for buyers. While it promotes fairness and transparency, it also imposes significant compliance obligations that can impact deal valuation and operational processes. Buyers must carefully consider these factors and seek expert advice to navigate the complexities of the directive.