How An Employee Bonus Can Help You Sell Your Business

One of the biggest risk factors for a business buyer is turnover of key employees in the company after the business is acquired.  One of the biggest risk factors for a business seller is that around the time he wants to sell a key employee will leave the company, which may not only cause a decline in performance of the company but may also increase buyers'  perceptions of risk.  The greater the risk that a business buyer perceives when contemplating an acquisition, the less likely they are to complete the deal and pay a premium price.  

Is there really much that can be done about this?  After all, you can't force key employees to continue working for the company.  You can, however, create attractive incentives for key employees to stay.  If you structure it the right way it may help you sell your business, and possibly get a higher price.   

How to do so?  Create a bonus for key employees who remain employed after the business is sold.  Codiligent business brokers are not experts at compensation or bonus programs.  However, we would encourage you to discuss the following ideas with professionals who have deep knowledge of employee compensation plans:

• Ideally you don't want a key employee to only stay up until the date that you sell, but rather it will usually be in both your and the buyer's best interest to encourage them to stay on long after the sale.  Consequently, consider paying at least part of the bonus one or two years after the business sale transaction closes.

• One of the challenges with setting up a bonus program as a way of encouraging retention through the sale process and post closing is that if it is promised to key employees too early, it may need to be larger in order to be compelling (i.e. a $50,000 bonus that will likely occur in two years, is quite a bit different than the same dollar amount being earned after seven years).

• You may want to use the bonus to help incentivize key employees to help you increase the value in the business while also putting golden handcuffs on them.  How?  Have the business professionally valued now.  Then have the bonus be at least partially based on an increase in the value of the company.  When you sell the business use the same business appraiser and have them use the same methodology previously used to value the company, and then use the increase in value as part of the pre-agreed-upon bonus formula.  Why not use the actual purchase price compared to the prior value estimate, since the actual price could be higher or lower?  Because using a consistent methodology makes it fair for the employee (i.e. what if the employee objectively helps increase the value of the business but you agree to a lower price with a business buyer; or how does the employee know that the starting value is accurate, maybe the starting value should have been lower which would have resulted in a larger gain.).  By having the bonus tied to an increase in a valuation methodology it closely aligns the key employee’s interests to the seller’s interests.  Codiligent offers a program called Always Ready To Sell in which the business is valued and fully packaged, and the value and packages are updated monthly so that a business owner is always prepared to sell.  Given that a consistent valuation methodology is used in this program every month, participating business owners could use it as the basis for calculating the bonus.

• The problem with having the retention bonus tied only to an increase in business value is what if, despite the key employee's best efforts and high level of skill, the business value doesn't increase?  This could be due to things like a decline in the general economy, a new competitive threat, or the loss of a few key clients that the key employee couldn't influence.  Yet, perhaps performance of the business would be even worse if the key employee was not employed by the business.  In such a situation it may be even more critical to retain the key employee.  So a business owner may want to consider a bonus that has two components:  a fixed base bonus amount plus a share of the increase in the value of the business.  

• Consider having the increase-in-value portion of the bonus be based on performance at the time of sale of the business (and not beyond), but deferring payment of the bonus (or a large part of it) until one year post sale and dependent on the continued employment by the acquirer.  This may make the employee nervous because they can’t control whether a new owner retains them - so you could agree to pay the bonus out earlier if the buyer terminates the employee.  However, that creates some moral hazard - because if the key staff member wants to leave they could participate in activities that would encourage termination.  Another way that may be better for handling this is to give 50% of the bonus to the employee at the time the business sale closes, and the remaining 50% if they continue to be employed by the company a year later.  

• By setting up such a bonus program at least a couple of years before an anticipated sale, it not only increases the likelihood of retention of the key staff member which may help protect value, but it can also allow you to be less secretive with key employees about a sale.  Most often I recommend that owners keep business sale intentions confidential from key staff members, but if there is a strong bonus a key employee who learns of a potential sale may be more excited about a big upcoming pay-day, than becoming nervous about the transition and looking at other employment opportunities.  By aligning your interest with your key employees' financial interests you may be able to let them in on your secret of selling, and they can be a useful and active ally in helping you sell the business. However, keep in mind that if the bonus is going to be a more modest amount, you may still want to keep the sale process confidential from key employees.  

• Most business buyers will be concerned about retaining key employees beyond one year.  During the sale process you can invite the buyer to offer the key employee an additional bonus after two or three years of service.

What's an appropriate amount for a retention bonus? Here are some of the factors to consider:

• How important is the key employee to the business.
• How difficult would it be to find a replacement staff member.
• Whether the company has key client, vendor, or strategic partner relationships where the key employee is the primary contact and the departure of said employee could result in termination or damage to the company’s continued relationship these stake holders.
• The redundancy of functional skill sets and degree of cross training within the organization.
• Whether knowledge the key employee possess is codified in systems or whether when they depart the company loses what was in their head.
• Whether there is an enforceable non-compete / non-solicit in place and/or if there isn’t then the degree to which the employee going to work for a competitor would harm the company.
• Reputation of the key employee in the industry.
• The market rate of compensation for their position.