Deal Killer #4: The Failure to Preserve Key Employees
Key employees are a major factor in differentiating a business. They can make or break a business, especially as business owners approach their exits. Consider the story of Chuck Glass and his advisor, Shirley Locke.
Shirley Locke, ace Exit Planner, listened patiently as Chuck Glass, a business owner and new client, proclaimed his eagerness to sell his company based on an unsolicited yet attractive offer he’d just received. Like many owners, Chuck felt ready to exit today and was certain that his company was as ready as he was. He had only one question for Shirley, “Can you look over this Letter of Intent (LOI) before I sign it? It seems fine to me.”
We’ll follow Shirley’s lead, save the discussion of the issues unique to Letters of Intent for another time, and move instead to her first question: “Can you tell me a bit about your company?”
Shirley quickly zeroed in on the fact that Chuck’s company had experienced extraordinary revenue growth due in large part to Chuck’s decision to hire a next-level management team four years earlier.
Shirley then asked, “Chuck, I’d like to see the Covenant Not to Competes or Non-Solicitation Agreements that your new managers signed as part of their employment agreements. Do you have them with you?”
“Well no, because they don’t exist,” Chuck admitted. “But that’s not really an issue. I pay this team very well and they’re very happy.”
“I hope they are,” said Shirley, “but let me tell you the story of another owner who thought the same thing about his team. I heard this from an investment banker, and I think of it as ‘The Case of the Blackmailing CIO.’” Shirley had heard this story at Boot Camp for Advisors from BEI Member and investment banker Kevin Short:
This owner was a week away from the sale of his company for $10 million when (at this very late stage of the game) the buyer met with each of the key managers to reassure them that they’d be retained by the new owners at their existing compensation levels. At its meeting with the Chief Information Officer, the buyer was lavish in its praise of her performance and indicated how important her continued involvement was to the company’s future success.
When the buyer then asked her to sign a covenant not to compete before the closing date, the CIO asked for a short break and headed straight for the owner’s office. She reminded him that she’d built (and maintained) the company’s data warehouse and custom app allowing customers to access and change orders (one of the company’s competitive advantages), and generously consented to wait patiently until the closing date “to collect her $1 million bonus.”
This owner paid the ransom because he knew that if his CIO—who managed the company’s intellectual property by herself—left the company, the buyer would likely scrap the deal. If the buyer did subsequently come to the closing table, it would reduce its purchase offer by far more than $1 million.
Chuck immediately understood the morals of Shirley’s story. Replacing an owner as the center of the company with a management team is a critical component of creating transferable business value. Buyers insist on this, and it's necessary for advisors to help business owners understand why and understand how to plan around it. Owners sometimes overlook the fact that with the relocation of management to the hub of the business, there is an accompanying threat: Management team members can leave the company; compete; and take important relationships, customers, employees, vendor relationships, and more with them.
Chuck realized, a little late in the game, that he should do all he could to prevent employees from harming his company, or his ability to exit, by creating enforceable covenants and agreements.
Shirley gently suggested to a somewhat chastened Chuck that he meet immediately with best-in-class legal counsel to create the necessary documentation.
We find that it is unusual for owners to create the safeguards necessary to protect their companies. It is equally unlikely that owners’ current advisors will suggest that they do so. As a result, nothing is done to protect the company’s most valuable asset, but quite a lot has been done to create a potent Deal Killer. Owners need advisors to help them navigate the fog and protect their exits from overly ambitious key employees.
Advisors must help owners understand and implement a strategy to tie key employees to their employers with stronger bonds than feelings of good will. Kevin Short's story shows that even key employees that seem loyal can bring unexpected (but ultimately avoidable) problems to a business exit. If an owner's legal counsel does not have expertise in employment law, the Exit Planning Advisor has the tools and networks to find and recommend one who does.
- We discuss the need to hire next-level management as a pre-condition to rapidly increasing business revenue and cash flow in Chapter 3 of Exit Planning: The Definitive Guide.
- Kevin M. Short is CEO and Managing Partner of Clayton Capital Partners, an investment banking firm headquartered in St. Louis, Missouri.