Retaining Key Employees - a Business Transition Expert Extra!

By Tom Bixby, President & CEO, LEVEL Management Partners
Published April 28, 2016

LEVEL Expert Network™ member Michael Rosenthal, Business Attorney with Wagner, Johnston & Rosenthal, P.C., contributed to the Value Growth Series™ article "Business Transition - People and Taxes". Here, Michael shares additional insights on how business owners can retain key employees through a business transition.

Business owners considering an ownership transition should be aware of several important tools to motivate key employees to stay through the transition:

  • Restrictive Business Covenants (not to compete, solicit customers, hire employees)
  • Equity stakes with claw-back options if employee leaves early
  • Stock appreciation rights or phantom stock
  • Stay bonuses

Restrictive Business Covenants

Whether or not you have current plans or goals to sell your business, all key employees, and especially those with sales or customer relationship roles, should have some form of restrictive business covenants in place, such as covenants not to compete, covenants not to solicit customers and covenants not to hire employees. These are necessary tools in helping your employees recognize that if they leave your employ, they will be starting from scratch with respect to these critical customer or employee relationships. These covenants may make these employees less attractive to your competitors too.

Depending on the state where your employee works, these covenants are generally enforceable if they are properly drafted and not overly burdensome with respect to:

  • The restricted time period (for example, two years post-employment)
  • Geographic territory covered and scope of work prohibited (there is no reason to stop a CFO from quitting and working elsewhere as a janitor)

Equity stakes

We [Wagner, Johnston & Rosenthal, P.C.] generally recommend that business owners whose long term goal is the sale of their business consider giving a few key employees small equity stakes in the business which may vest over time or be “clawed back” if the employee leaves before the sale is achieved. This gives the employee an obvious stake in the company and its success.

Stock appreciation rights

Another option we’ve used is giving the key employees stock appreciation rights or phantom stock, which basically is a contractual right to receive certain payments if the value of the company increases over time. I had a software company client create such a program many years ago. It helped retain a number of key employees, including a lead software developer. When the company was sold to a public company, that developer received a cash payment of about $400,000 for his loyalty. Incidentally, he used those funds to start his own business and has become a highly successful serial entrepreneur.

Stay Bonus

Yet another tool we’ve used frequently once it becomes known that a company is up for sale or engaged in active merger discussions is a “stay bonus”. A stay bonus pays key employees if they remain with the company through a certain date, or through a sale. After the sale, it is up to the acquiring company to then provide an incentive to those key employees to remain as part of the team. In my experience, at this point post sale, it is rarely about money, but rather it is about how that key employee perceives their role in the bigger enterprise and how they are treated.

Corporate Culture is Critical

I can remember one unhappy employee calling me post sale and saying “I spent most of my working life helping building this beautiful butterfly; I’m not going to stick around and watch that SOB (acquiring company CEO) pick the wings off my butterfly. “ That employee left a few months later. I personally believe that at some point early on, an open conversation between the business owner and any key employee regarding the long-term goal of the business owner to sell the business is essential.

If you want to know what might motivate a key employee to stick around, you might actually consider simply asking them. I had a long-term client that was acquired last year by a private equity firm. Part of the process started years ago with the business owner discussing his retirement goal with several key employees. One of those employees is now the CEO post-sale, and all three key employees received modest stakes in the company as part of the private equity transaction. One of the critical elements of the deal was the employees’ goal to continue running the business with a high degree of autonomy. This helped the business owner focus on who might be an ideal buyer, and the ultimate buyer is truly “hands-off” the management team so long as they continue to grow the business. So far, they are doing that very well.

View the full article on Business Transition - People and Taxes

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