When we talk to business owners about the value of Exit Planning, we are talking about planning their exit from their business in a manner that fulfills their unique financial and personal goals. Since tackling a task of this magnitude can be daunting, owners sometimes ask whether devoting the necessary time and money to this project is really worthwhile.
In working everyday with owners of small and mid-sized companies, we have learned that failure to plan for the owner’s exit can mean the difference between a successful closing of the ultimate sale of their business and a complete derailment of the sale process.
According to Kevin Short, an investment banker who works with owners of small and mid-sized companies, “The element of Exit Planning that gives an owner the biggest bang for the buck is, without a doubt, Step 3 of The Exit Planning Process: Building and Preserving Value.”
One of the “Value Drivers” used to build and preserve value is called a Stay Bonus—a technique we use to motivate managers to remain with a company post-closing. An effective Stay Bonus accomplishes three tasks:
1. It gives the key managers a reason to stay.
2. It is structured so that it increases the value of the company.
3. It includes a penalty (usually in the form of a covenant not to compete and a non-solicitation of customers and employees) that prevents key managers from taking key clients, vendors, employees or trade secrets with them should they leave before or after the sale.
There are far too many horror stories about owners who, believing that their loyal employees were happy and already well compensated, have been held hostage by those same employees.
For example, we represented a business owner who was within a couple of weeks of closing on the sale of his company when the buyer met with each of his key employees to reassure them that they’d be retained by the new owners at their existing compensation levels.
At its meeting with one of the owner’s top salesman, the buyer was lavish about how important the salesman’s continued success was to the company’s future success. When the buyer then asked the salesman to sign a covenant not to compete before the closing date, the salesman asked for a break and headed straight to talk with the owner. He reminded the owner that he had helped build the company to its current value during his tenure, and ever so generously consented to wait until the closing date to collect his $1 million bonus.
Our client paid the ransom. He understood that if the salesman servicing one of his top clients left the company, the buyer would likely scrap the deal. If the buyer did come to the closing table, it would reduce its purchase offer by $3 million—far more than the $1 million the salesman demanded.
As a result of this and many similar experiences, we recommend that owners get very aggressive about implementing Stay Bonuses long before a sale is planned with anyone who has a significant impact on a company’s performance. In most cases, instead of $1 million, the Stay Bonus would be calculated at 50 percent to 200 percent of an employee’s annual compensation and should be tied to a covenant not to compete (or similar agreement).
As Exit Planning advisors, we also work with owners to protect business value. One method is to clean up shareholder agreements (again, well in advance of any contemplated sale or transfer of the business).
“If a shareholder agreement does not force a minority shareholder to sell when the majority shareholder does, majority owners can (and often do) find themselves unable to sell, or held hostage by minority shareholders,” Short observes.
“By and large,” adds Short, “entrepreneurs ignore both Stay Bonus plans and shareholder agreements because they believe that other shareholders or employees will ‘come along’ on closing day.” Short observes, “What owners forget is that every shareholder and every employee figures out leverage and most intend to use it.”
From these and many other examples from our practice, we believe that Exit Planning is indeed well worth the time and money owners devote to it as these and other issues which desperately need to be addressed are “flushed out” and fixed during the Exit Planning process—long before it costs the owner huge amounts of money.
Article presented by Robert Norris, founder and managing partner of Wishart Norris law firm, a member of Business Enterprise Institute’s International Network of Exit Planning Professionals. © 2013 Business Enterprise Institute, Inc. Reprinted with permission. Wishart Norris law firm partners with owners of closely-held businesses to provide comprehensive legal services in all areas of business, tax, estate planning, exit planning, succession planning, purchases and sales of businesses, real estate, family law, and litigation. For more information, contact Robert Norris at 704-364-0010 or Robert.Norris@wnhplaw.com.