Executive Report

Key Employees Can Ruin The Sale Of A Business

Many companies don’t consider the potential impact their key employees may have when a business is sold. That oversight can have disastrous consequences. Business sales have many moving parts, and employees are crucial to a business operation and its success. This key piece, however, is often overlooked. 

Navigating the Non-Compete and Non-Solicitation Agreements

There are two contract elements you need to protect yourself when selling your company. These should be in any employee/severance contract, but in business sales, they become noticeably more important. They are non-compete and non-solicitation clauses. 

Non-Compete Agreements are contracts between the employer and the employee which state former employees are not allowed to compete in the same market for a specified length of time. This means the employee signing the agreement will be unable to start a competing new business within a specified territory and time period. They will likewise abstain from working for competitors of their previous employers in the previous employer’s reasonable geographic marketplace.   

These clauses should be integrated into employee contracts upon hire, but also may be negotiated by mutual agreement upon the termination of their relationship. Ideally, such agreements should be a contractual pre-condition as a part of the agreement for hire, but during business sales or severance packages, they sometimes include a financial benefit for agreeing to not compete.  

Non-Solicitation Agreements are similar. These simply mean that employees are unable to solicit business from your company’s clients and unable to solicit your employees for the agreed upon time period. 

In order for these agreements to be held up in the court of law, there are two obligations that must be met: 

  • Specifications for the agreements must be outlined. These specifications must include the area or region in which the employee may not solicit clients or start a new business, what will constitute a contract violation, and how long the contract will be in effect. 
  • Damages and compensation must be included in the contract. How much are employees being compensated for signing the agreements? What are the penalties for violating this contract? 

Another thing to keep in mind is that the contract agreements must be reasonable. Large, unfair contract violations, tricky wording, or designating an excessively large territory (or a territory out of the company’s reach) or too long of a time period can be challenged in court. 

Some states also do not recognize Non-Compete Agreements. Others only accept the agreements conditionally, generally siding with the employee. 

Sales Are Contingent on Key Employees

The actual sale may be leveraged by key employees to garner additional benefit for themselves. This is not altogether unexpected, especially in cases in which a business sale means an employee may be losing his or her job. 

I had a case in which the majority shareowner of a company had passed away while his business was in the center of a sales negotiation. Shortly after his death, his widow filled in, being the new majority stakeholder. She had to be counseled about how to continue with selling the company, conducting negotiations, and what to expect. The widow wanted to keep the company, but her advisors suggested that attempting to run the business without knowledge of the business’s operations would hurt more than help. 

One of the key employees brought up that he didn’t have a non-compete and would walk down the street and start up a similar business with some of the other employees if he wasn’t provided some economic compensation. After an emotional set of new negotiations, he was eventually given an equity ownership in the business.  

This is a great example of how a key player can drastically change business sales negotiations. Real people are affected by business sales, and if they have leverage, they may choose to use it. The widow saw the business as a type of memorial for her husband, and a key player saw the recent death as an opening to leverage his company expertise.  

Maryland, like most other states, is an at-will state. Employees may quit at any time, and if they know a business sale is pending, many will immediately begin looking for other work. They may negotiate an economic safeguard to their situation during the sale in the form of a retention bonus. A retention bonus is a benefit in addition to normal pay and compensation as incentive for an employee to stay for the duration of the sale or to accept employment with a purchaser. This benefit can be in the form of stocks, a company car, or money. The point is that the key employee knows he or she has leverage over the selling company. 

The Emotional Buy-In of Key Employees Also Matters 

There are no rules for how much information you share with employees before a company sale. Without a plan for disseminating the sale information, you may find a host of angry employees knocking down your door. Not all employees will leverage for employee compensation, but all employees demand to be treated with respect. 

I had another situation in which a business owner had spent months negotiating the sale of his company. As usual, there was a type of courtship involved with the sale requiring a great deal of time and due diligence on both sides of the table. After working with the buyer and about to be handed the check for his company, the seller finally broke the news to his employees. 

The backlash was immediate. The seller’s employees were livid. Feeling unprepared for the deal, they were extremely unhappy with the news. After feeling the pressure, the owner decided to cancel the deal and adopted an ESOP to create an economic benefit/motivation to grow the value of the private company equity. The owner was happier despite getting far less than he would have in the deal, and the employees were certainly pleased with the outcome. However, the potential buyer took a loss for all the money and time spent working on the negotiations. 

Sharing information with your employees, especially key players and stakeholders in the company, is key. When staring at the prospect of gaining millions while unburdening yourself from the huge responsibility involved with running a company, it can be easy to forget that many employees may be loyal to you and your management style. 

The takeaway from the above example is that employees can be given more than just money to stay with the business. As a business owner, you are accountable to your employees and must include and inform them in a situation like the sale of the business. 

To determine if your company is ready (and possibly threatened by key stakeholders) for selling, take the BERI assessment on LenMiller.com. This test will help sift through some of the financial and emotional variables to determine a transaction’s potential liability. Key employees are just one component to selling, and this assessment walks you through 13 more.  

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