"*Article originally published on CityBizList"
Two interesting conversations played out recently – one dealing with the fallout from employees who tried to hold a company sale hostage, the other tentatively exploring how to give employees in advance a stake in the future.
(Mis)Alignment. Whether accepted or not, the value of most companies lies in the talent that arrives at work every day. While we’re all fungible at a certain level, try testing that proposition with a prospective buyer who worries whether your team will show up after closing. Inevitably, buyers focus on what’s going to keep employees engaged once the deal is done – seller’s talk about culture and team and passion only goes so far. And noncompetes and similar restrictive covenants alone are seen as a hostile solution. The reality is buyers want to ensure key employees are financially aligned not only with the transaction but with the future. At a minimum, this means having a financial incentive to hang around, and hopefully, having a real stake in the future that follows.
The Deal is Rigged. More often than not, entrepreneurs face the reality that their employees can hold their deal hostage late in the game. Some get off easy by tying “loyalty” to a deferred payment that does little more than ensure that employee’s appearance after closing. The risk of buying off one employee is that others, catching rumor of it, line up. The worst I’ve seen is a deal killed by a workforce who wouldn’t play. That company ended up years later with an ESOP, a decent enough result, but left the owner entangled with the company and his (former) employees longer than desired. In another busted deal, the general manager, whose own desire to buy the business was thwarted, literally walked off, with disastrous results for the company.
Setting the Stage. While venture capital is a much maligned form of investment, the irony is that venture backed companies usually get the employee ownership piece right through a well-designed option plan with meaningful stakes for key employees. In fact venture capitalists often test whether the entrepreneurs they’re considering backing understand the importance of employee ownership – reluctant to fund entrepreneurs who have resisted providing stakes to their team and frequently requiring the recalcitrant to initiate option grants as a condition to their financing. While an option plan isn’t for every company, the recognition that key employees are critical to the future success of the enterprise is. VCs realize that compensation plans should align employees with their own growth and exit goals.
When to do What? There isn’t any easy answer for how to ensure employees have a stake in the future. Equity in a myriad of flavors, including profits interests and stock options, might work in some cases. Bonuses and deferred payments might work in others. Entrepreneurs can get burned as well by providing too rich a package or not realizing the cumulative impact of a series of grants. One also has to sort through what to do when an employee leaves prematurely – Is the interest forfeited? Is its value capped? What about repurchase? Designing such a strategy is complicated. But avoiding, deferring or ignoring the issue only increases the risk of a real challenge when the time comes to sell. Tentative steps are better than none at all. And a strategy that you as seller control is better than any that the buyer will impose late in negotiations.
With more than 25 years’ experience in law and business, Newt Fowler, a partner in Womble Carlyle’s business practice, advises many investors, entrepreneurs and technology companies, guiding them through all aspects of business planning, financing transactions, technology commercialization and M&A. He chairs the Board of TEDCO and serves on the Boards of the Economic Alliance of Baltimore, and Big Brothers Big Sisters of the Greater Chesapeake.