This blog is coauthored with Paris Aden; Partner and co-founder of Valitas Capital Partners. Paris has broad industry experience with a focus on energy, materials, industrial and consumer products. He has been involved in over 100 M&A transactions with a value exceeding $80 billion. Paris is concurrently a lecturer at The Stephen J.R. Smith School of Business at Queen’s University in the Master of Finance program and an M&A subject matter instructor for Moody’s Analytics’ Advanced Capital Markets Program for capital market professionals.
Transitioning the ownership of a business is a significant undertaking that requires the involvement of key members of the management team. As the sale process progresses, buyer due diligence will become broader and the number of people that need to be involved will grow. Keeping these key team members focused and motivated during a stressful and uncertain time will be a challenge. Employees will quickly make assumptions about their potential future as a consequence of the transaction. The sale of a business is not a time to have disengaged employees or untimely departures in important positions on the transaction team. If not managed properly, poor engagement can harm the sale price, or worse, kill a deal. It’s in an owner’s best interest to motivate support for the sale.The time and effort required to complete a transaction should not be underestimated. Preparing detailed operational and financial reports and other due diligence materials, responding to requests from potential purchasers, integration and planning the transition of the business following the sale, amongst a myriad of other things will be added to the team’s normal day to day responsibilities. Selecting an internal M&A team should be one of the first steps in a sale strategy often before a buyer has been identified. This starts with the CFO, who will carry the major share of the additional work, often involving weekends and late nights. Other members will be added as their involvement becomes necessary. It will be important to financially motivate the team’s commitment to the transaction, while minimizing the personal concerns and uncertainty that might give rise to distraction. Owners particularly at a time of transition feel an obligation toward a loyal workforce and to the culture they have helped shape, which may influence the introduction and size of incentives to facilitate an orderly transition. The type and size of incentive will ultimately depend upon the staff the buyer may want, the work required, and organizational culture. The choice of incentive may include:
- No Incentive – Hoping that members of the transaction team will stay and shoulder additional work notwithstanding that they may lose their positions after completion is a high risk strategy unless they can be assured that their employment is going to be continued by the purchaser. Absent an assurance of a position or an incentive to stay the team’s economic livelihood will be directly opposed to the intentions of the owner and the sale of the business.
- Completion Incentive – This type of incentive is used to motivate completion of the transaction and to shoulder the additional workload when future employment is at risk. They are payable by completion of specific tasks and/or successful transition of ownership. Amounts will reflect the size of business and the team member’s position and may be a specific amount or a percentage of salary e.g. 100%.
- Retention Incentive – Such an inducement would be similar to a Completion Incentive but would in addition hope to motivate employees to remain with the company thru and beyond the sale, payable on a date following completion of the transaction.
- Change in Control Arrangements (CIC) – Provide enhanced severance pay following a change in ownership and transfer of employment to the new owner. There are two types. The first may be activated by the employee (known as a single trigger agreement) and the second comes into effect after the change in control and following termination by the new employer (a double trigger). Typically CICs are in effect for a defined period, typically one to three years and are settled in cash but may include continuation of benefits.What constitutes termination would be defined but typically include constructive dismissal such as a change in responsibilities, title, work location, etc without the employee’s agreement. These arrangements are usually offered to senior employees or those with unique skills or knowledge that it is perceived may have an initial purpose with the new owner but not a long term role. Executives are the most vulnerable during ownership transition and will have the greatest concerns about transitioning to a buyer. They are a group however, whose full attention will be required during the transition and these agreements represent are intended to represent both an incentive and security.CIC provisions are often offered as a permanent feature in executive employment agreements whether a sale is immediately envisaged or not. They have no cost until triggered and are attractive to new recruits who perceive the likelihood of an ownership change in the future.
Retention Incentives are an additional cost but represent a small percentage of sale proceeds should the transaction close and nothing if it doesn’t. The cost is insignificant compared to the sale value and will mitigate the risk of the transaction failing and potentially, in the best scenario may help to obtain a premium valuation. The objective of a transaction related incentive is to enhance the employee’s safety net during a time of uncertainty and to motivate the necessary additional personal contribution. Motivated employees will be attractive to a purchaser who may prove willing to share the cost to avoid the expense of recruiting replacements following the transaction.