In this post, we will examine a common Deal Killer that owners not only fail to consider but also often create themselves: not protecting the business’ most valuable asset—capable, committed management to run the business after the owner exits. Consider the following example.
Gus and Good Will: Don’t Let Employees Do You Harm
Carol, a well-decorated Exit Planner, met with Gus, a business owner and new client, to discuss Gus’s eagerness to sell his business. Gus received an unsolicited albeit satisfying offer for his business. Like most owners, Gus assumed that his business was just as ready for his exit as he was. He had one question for Carol: “Can you look over this letter of intent? It seems fine to me.” Before even considering the letter of intent, Carol asked Gus more about his business.
Carol focused on the fact that Gus’s business experienced exponential revenue growth based on Gus’s decision to hire a next-level management team, a decision Gus made four years earlier. She asked Gus to show her the business’ non-compete covenants or non-solicitation agreements that he had created for his management team as a part of their employee agreements.
“I would, but they don’t exist,” Gus said sheepishly. “But that doesn’t matter, right? I pay my managers well, and they’re happy.”
This is an assumption that many owners make, especially when hiring next-level management teams. While it’s good for owners to trust that their employees are satisfied, it is much better to assure in writing that the employees cannot do the business harm at any time during an owner’s exit. Consider the story that Carol told Gus after hearing it from Kevin Short, CEO and Managing Partner of Clayton Capital Partners, while attending the BEI Boot Camp for Advisors™.
Bruce Gets Blackmailed: The Case of the Blackmailing CIO
Bruce, a business owner, was one week away from selling his business for $10 million. However, he, like many other owners, had never created or considered an employee non-compete covenant. One week before the sale, Bruce allowed the buyers to interview each of his key managers to assure them that the new owners would be retaining each one of them. After their meetings, the buyers expressed how impressed they were by Ken, the business’ CIO, and said that they considered Ken’s continued involvement a key to a successful transfer.
When the buyers asked Ken to sign a non-compete agreement before the sale closed, Ken asked for a short break to consider. He immediately went to Bruce’s office. He told Bruce that he had built and solely maintained the business’ data warehouse and a custom app that allowed clients to access and change orders directly, which was one of the business’ competitive advantages. He told Bruce that he would wait until the deal was closed and then accept his $1 million “bonus” from Bruce for all of his work.
Bruce, who had never considered that Ken would do such a thing, paid the ransom. He knew that if Ken left, the deal might be scrapped altogether, since Ken’s role in the transfer was pivotal. Even if the buyers came to the table knowing that Ken would be leaving, Bruce knew that he stood to lose more than $1 million from the sale without Ken’s continuing presence after he sold.
Gus’s Goal: Create a Covenant
After hearing Carol’s story, Gus flinched. He understood how important it was for him, as an owner, to have a ready, willing, and able management team to continue the business’ smooth operations in his stead; he knew this was critical to his deal. However, he, like most owners, ignored a common threat: that someone in management can and will leave the business, take all of his or her intellectual property with him, and then compete against his or her old company using the business relationships and systems he or she had accrued and created.
Gus then realized how critical it was for the future success of his business and exit that he create enforceable covenants and agreements. Though late in the game, Carol recommended that Gus immediately contact his best-in-class legal counsel to create the proper covenants.
In BEI’s experience, we find that it’s rare for owners to create the proper safeguards to protect their businesses by themselves. It’s equally rare for owners’ advisors (before they come to BEI) to suggest that their clients implement such safeguards. Thus, owners not only do nothing to protect the business’ most valuable asset but also effectively create and foster a Deal Killer.
If you, as an Exit Planning Advisor, have not yet discussed with your clients the notion of tying key employees to the business with bonds stronger (and more legally enforceable) than good will, do so immediately. You must explain to them the dangers of trying to sell their businesses without appropriate safeguards in place. Finally, if your client’s legal counsel does not have experience or expertise in employment law, it is your job, as an Exit Planning Advisor, to find someone who does for your client.
If you would like more information about how to present this common challenge to your clients, please contact us today.