Locking in Key Employees for a Future Exit
Updated: Dec 13, 2021
So, you’ve built a successful business and now you’ve decided it’s time to start planning your exit. It’s likely the biggest transaction of your life and you want to maximize the value. One way to do that is to start the planning process ahead of time and lock in your key employees.
What Is a Key Employee?
The IRS defines key employees as employees that have an ownership stake in the company or earn over a certain threshold (highly-compensated employees or HCEs). Those criteria are set more for tax and benefit reasons than operational issues. We like to think of them in broader terms.
Key employees are the ones that make your businesses run. They’re the top salesperson that always exceeds their quota, the person that solves problems and has great ideas, the person that’s developed long-term relationships with important customers, or the employee with unique skills and knowledge that would be difficult to replace. In other words, they’re the ones that would hurt your business if they left.
Why It’s Important to Retain Key Employees
To maximize the value of your business when planning your exit, retaining key employees is essential. Without strong and experienced leaders in place, it may hurt your value. It can also negatively affect a successful transition to keep your business healthy after you depart.
If your business performance depends on these key employees to run smoothly, a buyer is going to want assurance that they’ll stick around during the transition.
How to Keep Key Employees Engaged during a Transition
When thinking about ways to lock in your key employees, there are several factors to consider. First, you need to step back and make sure they really are key employees and not just someone that’s a good and loyal employee. Think about their motivations and the competitive landscape in your industry. The best incentives to keep your key employees engaged during a transition fit their personal needs best and depend on where they are in their careers and their aspirations.
Here are some of the ways business owners use to get key employees to stick around:
Employee Retention Agreement Example: A cash award if they stay for the transition and a payout if the new owner decides to go in a different direction
Stock Options Example: Key employees get a percentage of the sale or stock options based on performance
Phantom Stock Agreements Example: Key employees get a percentage of the sale, or cash rewards as if they had company stock
Profit Sharing Example: Key employees receive a share of the profits for continued performance or exceeding budgeted goals
Retention Bonuses Example: A retention bonus based on remaining at the business for a predefined period after the sale.
Whatever method you choose, they have to be more than just a “thank you” gesture on your way out. To be effective, they need to meet specific requirements that you can show to potential buyers. Any retention measures should contain specific and measurable goals and be tied to performance metrics. They need to be substantial enough that they’re worth sticking around for and they need to “handcuff” the key employees to your business.
They also have to be structured to encourage two specific, but different, behaviors.
Maintain or grow performance during the sale process
Give someone a reason to stay through the transition
Bonuses alone may not do it. In fact, they can disincentive employees who would just be counting down to the days until the sale goes through – unless they’ve got skin in the game after the sale occurs. One effective strategy is to create an incentive on a vesting schedule. You might award a portion of bonuses as milestones are achieved while holding back the remainder until a time in the future past the transition point. If key employees leave before they are vested, they’ll be forfeiting what’s unpaid.
When Should I Start Locking in my Key Employees?
The short answer is you should lock in your key employees right now. If they really are key to driving your business, you can’t afford to have them leave. Don’t wait until the last minute.
When you’re planning your exit, you’ll want to work with experts, such as Clear Advice Business, to evaluate your business, your key employees, and create the right incentives that will help build value. In most cases, this should happen several years before you plan to exit.
Some businesses make the mistake of waiting until a sale is almost finalized before reaching out to key employees. This is asking for trouble. If your employees find out a sale is in the works – and you haven’t talked to them about it – they may jump ship and hurt your value. It’s important to have the conversations well ahead of time and lock them in. After all, you want to sell your business but you don’t want your key employees thinking about leaving.
Communication is key.
How Clear Advice Business Helps Maximize Your Business Value
Clear Advice Business helps successful business owners prepare for selling their business and maximize their profit using a three-step strategy:
From benchmarking your business, developing your value drivers, enhancing your brand, assembling your advisory team, and facilitating the process, Clear Advice Business can help guide you through your exit strategy. Contact the experts at Clear Advice Business today to discuss your business and secure your future.