Sellers of privately held businesses usually know, well before they enter into negotiations to sell their business, that certain employees’ contributions are critical to its value. And most sellers also recognize that the departure of any of their C-level executives during the negotiations could make consummation of a transaction difficult. Nevertheless, most companies do little to insure that those key executives are properly incented to stay through the closing and beyond.
Some companies routinely issue their key executives equity (stock options, for example), and those actions can go a long way to motivating the key executive to stay through the sale (particularly if there is accelerated vesting on a change of control). If, for whatever reason, the Seller’s key executive does not have a piece of the company, the Sellers should consider the benefits of putting a “stay pay” package in place.
Here are the essential steps that a potential Seller should take:
- Identify the “key employees.” Generally that category will include any employees whose departure will significantly impact value, plus those who have an important role in getting the deal closed. Keep in mind that who is “key” will change over time, and in some instances will be different for different buyers. (Financial buyers, for example, may want to keep all C-level employees, while strategic buyers will often have little interest in retaining, for example, the CFO or General Counsel.)
- Review existing employment agreements and equity holdings. In some cases, the key employee may be sufficiently motivated by current holdings, and in some states you may have covenants not to compete in place that will restrict the employees’ alternatives. (But in California and some other states, covenants not to compete for employees without an equity stake are not enforceable; in some states the covenant may generally be enforceable, but is not assignable – meaning that the Buyer cannot enforce it and it is therefore of very limited value.)
- Design a program consistent with your needs. Typically the program requires the employee to stay through the closing, and perhaps for a period after the sale (30 to 90 days is common) to assist in the transition / integration. The payment is typically expressed as cash bonus equivalent to a portion of the key employee’s then current salary (three months to two years is not uncommon). Sometimes a portion of the bonus is paid at the close, with the balance payable if the employee is terminated.
- As part of the design of the program, determine if a “single trigger” of “double trigger” should be used:
- A “single trigger” means the employee receives payment on the closing of the change of control transaction, and sometimes adds the requirement of termination of employment for any reason. (As a practical matter, however, if the executive can receive the payment for quitting, it means that the Buyer will pay even if it decides to offer continued employment.)
– A “double trigger” means that the employee receives payment only following a changed of control – the first trigger – AND the termination of his employment without cause (or if the employee terminates for “good reason”) – the second trigger. Typically the second trigger must be pulled within a specified time period, for example within a year of the close.
- Have each key employee sign a written agreement reflecting such stay pay terms, and include a provision requiring the key employee to keep the terms, and the possibility of a sale, confidential
Most buyers are acutely sensitive to the importance of key executives to the value of the company, and will likely have little objection to the existence of such a program (particularly is a double trigger is required). Sellers must disclose the existence of any such program – at the appropriate time – and ultimately who must bear the financial responsibility for such program – the buyer or the seller – will be a part of the overall sale negotiation.