An important part of a successful ownership transfer, regardless of the exit strategy, is the presence of key employees. Key employees are those who have a direct and significant impact on business value, meaningfully participate in the business’s strategic future, and whose combination of skills and experience would be exceedingly difficult to replace.
Because of their role in the business, key employees can just as easily hijack and stall your business exit as they can facilitate it.
Consider the story of Max Valles, who had his business exit plan hijacked by one of his key employees.
The Exit Plan
Max Valles was nearing his retirement. Over 30 years, he had built his one-man plumbing company into a 55-employee regional powerhouse.
His ambition had led him to plan for his business exit on his own, based on information he had gleaned and absorbed over the years.
He recruited a business broker to assemble a deal team and find the right buyer.
The Trust and Transparency Approach
Over the last 15 years, Max had invested in training three key employees – Andrew, Peter, and Barry – to run specific portions of the business after he retired.
But as paperwork and contract administration were not his strong points, Max had used very simple employment contracts with these three key employees. The contracts had been copied from a plumbing mate many years ago, and no employment lawyer had ever checked the validity and composition of these documents.
Whilst his business broker fielded offers, Max gathered his key employees to tell them his intentions.
“I know I’ve been talking about retiring for a couple of years now, but I’m finally ready to pull the trigger,” he told them. “My broker’s gathered some offers, and we’re going to consider them this month.”
“That’s great,” Andrew said.
“Congratulations, Max!” Peter added.
“It’s about time,” Barry said cheerily. “You’ve earned this.”
“I couldn’t have gotten here without you all,” Max said, smiling.
“So, what are the offers?” Andrew asked.
Max had built trust with his key employees over their 15 years together and felt comfortable giving them an idea.
“A good amount. North of $10 million. And once we finalize the deal, you three will basically be in charge.”
Max told them that he would update them as he finalized the deal and adjourned the meeting.
Now It's Time for the Squeeze
Max eventually signed a letter of intent based on an $11 million purchase price, contingent on his key employees’ staying on to work with the company after the transfer.
Max then shared this information with the three key employees.
One week before he was set to sign off on the deal, Andrew requested a meeting.
“I want part of the deal,” he told Max.
Max was stunned. “You’re going to have more responsibilities, more pay,” he said.
“That’s not enough,” Andrew responded. “You said you wouldn’t have gotten here without me. I know what you’re selling for, and I want $3 million, or I’ll walk. I’ve got a few job offers on the table right now that pay better anyway.”
“I can’t do that,” Max said. “I won’t.”
“Well, good luck then,” Andrew said.
Andrew tendered his immediate resignation and began working for a direct competitor.
Max was forced to inform his buyer, who pulled the deal. He tried putting his business back on the market, but every offer he received was less than $5 million, based on the hole left by Andrew’s absence and his first failed attempt to sell.
One buyer offered his $7 million, but only if he stayed to fulfil Andrew’s duties for at least five years.
Max’s Mistakes
It took Max an additional five years to sell his business, but not for the money first on offer.
For as diligent as Max was, there were several pieces of his exit plan that he neglected: –
- He failed to incentivise all of his key employees properly, and "handcuff" them to the business
- He failed to have his key employees sign a covenant not to compete
- By trying to plan his exit by himself, and without an comprehensive range of exit planning expertise, Max overlooked several key aspects to a successful exit
It ended up costing Max millions of dollars and half a decade of his time.
As the saying goes … “forewarned is forearmed”. Knowledge in advance enables one to be prepared, especially when the issue at stake (a successful business transition) is so critical for the owner’s future happiness.
The information contained in this article is general in nature and is not legal, tax or financial advice. For information regarding your particular situation, contact a lawyer or a tax or financial professional. The information in this newsletter is provided with the understanding that it does not render legal, accounting, tax or financial advice. In specific cases, clients should consult their legal, accounting, tax or financial professional. This article is not intended to give advice or to represent our firm as being qualified to give advice in all areas of professional services. Master Planning is a discipline that typically requires the collaboration of multiple professional advisors. To the extent that our firm does not have the expertise required on a particular matter, we will always work closely with you to help you gain access to the resources and professional advice you need.
Any examples provided are hypothetical and for illustrative purposes only. Examples include fictitious names and do not represent any particular person or entity.
