In last week’s article, we discussed how business owners can protect the business by preventing departing employees from harming their companies. We suggested that advisors help owners offset the potential disadvantages of these agreements by simultaneously initiating incentive plans. Today, we pick up the discussion there: Can an advisor turn a potentially disagreeable confrontation between owner and employee into a win-win conversation?
Typically, as owners draw closer to leaving their businesses, they move farther from day-to-day involvement in operations. In the owner’s stead, key employees take over critical business functions (e.g., customer, employee, and vendor relationships). The business is most vulnerable at this point, especially if those key employees leave with any key relationships, because relationships held by a former key employee are difficult and time-consuming for owners to re-establish or replace.
The consequences of a departure are immediate:
- The owner’s exit is delayed.
- At a minimum, the transferable value of the business falls.
- Generally, the very existence of the business is jeopardized.
The task for Exit Planning Advisors is clear: help owners understand the potential for harm if they do nothing to protect their companies from the departure of a key employee. Skilled Exit Planners go beyond mitigating harm. They transform a difficult conversation into one that benefits both the owner and key employee.
Change the Focus: From Employment to Harm
We talked about the legal and relationship risks involved in presenting a covenant not to compete to current key employees in our previous article. An alternative is a non-solicitation agreement (NSA) combined with a non-disclosure of business information agreement. Because these agreements do not prevent your clients’ employees from leaving and competing with their businesses, employees are more amenable to them than they are to covenants not to compete. Once employees see that an owner’s goal is to protect the business rather than prevent employment, their concern decreases. Likewise, courts look more favorably upon these agreements because an employee is not limited in seeking employment.
BEI licensed members find that if employees are prohibited from taking other employees, customers, vendors, or proprietary information with them, their departure usually causes a minimal and temporary disruption to the company’s ongoing cash flow. That’s precisely what NSAs and non-disclosure agreements do. Most businesses do not need covenants not to compete to protect their existing value and revenue.
Motivate Key Employees
To offset or remedy an employee’s negative reaction to an NSA, advisors can create plans that offer the key employee a benefit greater than the perceived detriment of signing (i.e., an incentive compensation plan). An incentive compensation plan is the huge spoonful of sugar that helps the bitter pill of an NSA go down more smoothly.
Typically, benefit plans award both a cash bonus (as earned) and a deferred bonus designed to motivate the key employee to remain with the company for a given number of years. The bonus is usually based on improvement in some aspect of company performance, such as an annual increase in gross revenue or cash flow. If the potential bonus (cash and deferred) is significant—say 20% or more of the employee’s annual compensation—the perceived benefit to the key employee more than offsets the detriment of signing an NSA. The business is protected from loss and its management team motivated to grow business value and cash flow. This converts a distasteful ultimatum into a win-win opportunity.
An owner’s Exit Plan involves not only building value but also protecting assets in the form of customers, employees, vendors, and proprietary information. Exit Planners introduce the use of NSAs for key employees to protect those assets, in addition to a host of other business asset–protection tools.