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Retaining Key Employees Is Critical to Selling Your Business

From a seller's perspective, key employees benefit your business, but they can also hijack your exit strategy. When critical roles and proprietary business knowledge are concentrated in a few individuals, this poses a business risk to potential buyers.

When potential buyers evaluate your business, a key component they'll look for is the retention of key employees. They want to keep these individuals to ensure continuous operations after the business changes hands. If these individuals leave the company after it's sold, that will impact business performance and continuity.

So, how do business owners view and manage key employees when selling their business? An owner's first instinct is to downplay the importance of key employees when putting the business on the market, so as not to discourage potential buyers.

But denial is not a strategy.

In today's competitive market, you can expect savvy buyers to conduct a thorough investigation into your business, including your key employees and their likelihood of leaving the company. So, it's in your best interest to plan for key employee retention when hiring and to devise strategies to keep them long-term.

Who are Key Employees (KEs)?

Nearly every business in every industry has a few "indispensable" employees.

While not all employees are irreplaceable, you'll want to identify those who are essential because of their:

• Experience
• Industry knowledge
• Relationship with customers and vendors
• Involvement with critical development projects

You might not consider certain employees as KEs, but without them, the transition to new ownership will be compromised.

Senior executives will, in most cases, be considered KEs due to their experience, organizational knowledge, and relationships with key customers. The degree to which key employees impact your deal depends on the following factors.

Buyer Type

Competitors usually have a deep understanding of the industry, so they'll take a narrow view of the key employees.

However, financial buyers, such as private equity companies have greater dependencies and expect management continuity. Such buyers will likely retain the experienced management staff and key employees with a huge influence on customers.

Your Sales Cycle

What does your sales cycle look like? How much revenue is in your sales pipeline, and how vulnerable is it to disruption? If your sales pipeline is loaded, your indispensable employees would be high-performing salespeople and management, such as the VP or director of sales.

Your Customer Base

What's the composition of your customer base? How many of your customers are loyal? What percentage of sales come from loyal customers?

Again, if a large portion of your sales come from a few loyal customers, you'll want to retain the key executives responsible for managing those accounts to prevent disruption and loss of business revenue. If you have distributed customer sales, your sales team will not add much weight when determining your KEs.

What Buyers Will Want to Know

There is no clear-cut formula for determining an organization's key employees as the need may vary from industry to industry. Also, the people you deem "irreplaceable" in your organization might not be who the buyer will want to keep.

But in almost all cases, buyers will want to know:

• Who are your top sales representatives?
• Who would do much damage if they left for the competition?
• Who designed top-selling products?
• Who shoulders most of the workload in the company?
• Who has participated in critical business projects?

Based on this information, your key employees could be senior executives, product engineers, supervisors, operation managers, or even top-performing salespeople.

How Key Employees Can Hijack Your Business Exit Plan

Because of their role in your company, key employees can stall your business exit, frustrating all your efforts to transfer ownership. And nothing brings this point home more than what happened to this client, Thomas.

Thomas was nearing his retirement.

For over thirty years, he had built a Home Health Care business consisting of 55 employees. Thomas crafted a well-laid exit plan based on the information and knowledge he had garnered over the years.

When it was time to sell the company, he hired a business valuation specialist, who valued the business at $4.5 million. He then recruited a broker to put the business on the market and managed to find a potential buyer.

But things didn't go as planned.

Over his thirty years in business, he had trained and nurtured three key employees — Arnold, Donald, and Paula—to manage specific business functions.

Once the deal was ripe, Thomas assembled the three key employees to inform them of his intention to sell the business.

"I know I've been pondering when to retire over the past few years, and I feel it's now the time to pull the trigger." He said. "My broker has put the business on the market, and we've found a potential buyer."

"That's great!" Arnold said

"It's about time. You've earned it, Thomas." Donald said

"Congratulations, Thomas!" Paula added

"So, what's the offer? " Armand asked.

"We've settled with $4 million, and once the deal is finalized, you three will continue being in charge."

Thomas signed the LOI, Letter of Intent, that would get him the $4 million purchase price contingent upon his key employees staying in their current positions. But one week prior to closing the deal, Arnold requested a meeting.

"I want a part of the deal," Arnold said.

Arnold insisted that he was instrumental in the growth of the business and that he was entitled to a share of the business proceeds. He knew he was key to closing the deal, so he requested a $500,000 payout or he would quit.

"I can't do that," Thomas said.

Story cut short, Arnold turned in his resignation after Thomas refused to give in to his request, nullifying the deal. Thomas tried listing his business back on the market, but every offer he got was worth less than $4 million due to the vacancy created by Arnold’s resignation.

One buyer offered to buy the business for $3.25 million, contingent on Thomas working for three years to fulfill Arnold’s duties. It forced Thomas to extend his retirement by three years to fulfill Arnold’s duties and sell the business.

What went wrong?

Thomas failed to prepare his key employees for his exit strategy, which cost him a payout and three years of his life managing the key employee's roles.

Typical Key Employee Scenarios that Might Lock You Out of the Sale

Here are the three key employee hostage scenarios that might affect your business's selling price or even kill the deal.

1. The Respect Scenario

In this scenario, the business owner may be worried about confidentiality and fail to tell key employees ahead of time of their intention to sell. Often, there is no clear plan to get the employees involved in the sales process.

As a result, the key employees may feel disrespected and decide to walk.

If key employees leave during the due diligence, the sale could fall apart. If they leave after the sale is completed and you have an earn-out, it could cost you big.

1. Last-minute Scenario

This scenario is akin to what happened to Thomas. He chose to inform the key employees of his intention to sell at the last minute, which didn't go well.

Since key employees are essential to business continuity after the sale, they need to be kept in the loop. If kept in the dark, these individuals can compromise the sales process by quitting their jobs. Worst of all, some key employees might even have the power to take other employees with them, hijacking the sales process and at the same time paralyzing business operations.

Business owners can prevent key employees from quitting and soliciting other employees for recruitment purposes by introducing non-compete and non-solicitation agreements.

A non-compete agreement is a contract between an employee and employer where the employee agrees not to enter into any competing business for a specified period. This agreement prohibits the employee from leaving for the competitor or starting a competing business when selling your business.

A non-solicitation agreement, is a contract in which an employee agrees not to solicit a company's clients or customers, for his or her own benefit or for the benefit of a competitor, after leaving the company. A non-solicitation agreement can also include an agreement by the employee not to solicit other employees to leave when he or she quits or otherwise moves on.

Although most states allow enforcement of reasonable non-compete and non-solicitation agreements, they are largely unenforceable in California, North Dakota, Oklahoma, and the District of Columbia.

1. The Burnout Scenario

Employee burnout is common in the corporate world. In a Deloitte survey, 77% of employees said they had experienced burnout at their current job.

In some cases, key employees would want to stick around, but they are burnt out and want to start a new chapter in their life. On the other hand, the buyer may make the offer contingent upon the key employees staying.

In this case, trying to convince your key employees to stay at the last minute won't work, even if you raise their salaries.

How to Retain Key Employees When Selling Your Business

There are many things an employer can do to ensure key employees don't leave the business during the sales process. These include:

1. Introducing a Stay Bonus Agreement

With a stay bonus agreement, you provide key employees with financial incentives to stay through the sales process and for a period after closing.

These bonuses are structured such that the employees get a percentage of the bonus at closing, another percentage after 12 months, and so on.

The idea is to make them stay long enough to facilitate closing and assist the new owner until they're well acquainted with the business. These bonuses are usually given to irreplaceable figures like CFOs, controllers, etc.

1. Phantom Stock Agreements

A phantom stock plan is an employee benefit that gives key employees many advantages of owning stock in the company without actually giving them any company stock.

For instance, phantom stock agreements may be contingent upon a business sale, the amount of which is based on an agreed percentage of the transaction value.

For example, a key employee may have a "phantom equity" deal where they'll receive 0.5% of the sales proceeds. This gives them a reason to stay and perform through the transaction and stick around even after the sale.

1. Higher Salaries

Financial incentives not only promote employee retention; they also increase employee performance and productivity by 42% and 49%, respectively.

Your key employees need to be handsomely compensated before and during the transfer of business. Higher salaries give them a reason to stick around and walk with you through the sales process. It limits the chances of disruption while giving the new owner more reasons to trust that employees will continue to perform even after the business changes hands.

1. Additional Perks

Offering key employees attractive perks makes them appreciate their value and role in the company. Happy and satisfied employees are more likely to assist you with the transition and stick around even after the transfer. Consider offering them additional perks such as club memberships, automobiles, paid travel accommodations, etc.

Wrapping Up

When planning to sell your business, always remember to keep key employees in the loop. The buyer isn't only interested in your business's current cash flows but its future performance as well. And without key employees, business continuity will always be in question. 

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