In our discussions with business owners about today’s business challenges, for the past 18 months they list hiring and retaining good employees as one of their most significant challenges.
Business buyers are very cognizant of this situation; therefore, setting up a system to retain key employees will impact valuation in a positive manner.
Several years ago, our firm represented a very nice business, with over 30 employees, several of which were key employees that had been with the company more than 20 years. The business owner engaged our firm to market the business. However, without consulting our firm, and with the best of intentions, the owner informed his employees that he was selling the business. We warn owners never to do this. Several of the owner’s employees were told by their friend, neighbor, or relative, that the buyer would come in and make changes, and their position would be at risk.
While our experience is that buyers typically don’t make wholesale changes, several of the company’s key employees listened to bad advice and chose to leave the company. The value was negatively impacted dramatically.
Continuity of the management team is one of the most critical concerns of a business buyer
Our firm has been helping business owners since 1984 and has handled over 450 business sale transactions since that time with values up to $70,000,000. While there are a handful of important value drivers, we would say that the continuity of the management team is one of the most critical concerns of a business buyer. We hear this from private equity groups, industry buyers and high net worth individuals over and over – capability and continuity of management team is paramount.
If the management team is key to a successful business exit transaction – how does a business owner assure the buyer that the management team will remain? In the long history of our firm, this issue is a key component of the seller achieving maximum value. Many times, the buyer will insist on meeting with the general manager, or in larger transactions, as many as three to five key members of the management team prior to closing. Both the buyer and seller are invested in these key people remaining with the business after the sale.
Why use a stay bonus agreement?
An excellent solution to preempt the question of management continuity is to set up a “stay bonus agreement” with each key employee. The stay bonus should be put in place well ahead of putting the business on the market. A common reason is that the business owner’s “estate planning” advisors have advised the owner to put an agreement in place that protects the business in case of their death or disability. Stay bonus (retention) agreements are also handy in today’s “hot talent” market.
What triggers a stay bonus agreement?
The stay bonus Agreement is “triggered” upon the occurrence of one of three events: death of the owner, disability of the owner, or change of ownership of the company. The stay bonus agreement will typically provide for a cash payment upon the occurrence of any of the three above-mentioned events, plus a second payment at the end of twelve months, and sometimes a third payment at the end of twenty-four months. To receive payment, the employee must be employed by the company on the dates set out in the schedule. The amount of the bonus must be significant enough to the employee to accomplish the objective. The suggested amount would be a bonus equal to 50 – 100% of the employees’ annual compensation. In the instance of a twenty-four month stay bonus, one third would be paid at the date of the triggering event, one third at the end of year one, and the last third at the end of year two. Payments are deducted as normal compensation, deductible to the company and taxable to the employee. The three events noted above as “triggering” events put the company in need of management continuity during a transition period.
Stay bonus agreements benefits:
- Ensures a trouble-free transition. Retaining key employees during the business transition provides continuity in critical company processes, avoids disrupting workflows, services or manufacturing, and ensures the on-going cash flow of the business. Without key employees who understand operations, management may not have the skills and knowledge needed to move forward.
- Helps retain key employees. It is essential to keep key employees on board through the transition so that those employees can continue to add value to the during this critical time.
- Preserves key client relationships. Key employees typically have strong relationships with customers. Customers are more likely to remain loyal to a company that retains the employees with whom they have long standing relationships. Stay bonus agreements help prevent customers from leaving a business in favor of its competitors.
- Improves morale. Offering a stay bonus to key employees may make them feel valued, which in turn leads to improved productivity and long-term retention.
While this article outlines the concept and gives suggestions for how to structure the payments of the stay bonus, your attorney will prepare the stay bonus agreements. The funds invested in putting this process in place will generate significant returns, both in the negotiations of the price of the business and support the due diligence process as key employees who have met the acquirer can help provide the information requested.