The Value Builder Series
Helping business owners build valuable businesses
Through our Business Value Builder Programme we work with clients to build long-term value in their business. We help them by critically analysing their business to identify and leverage the key value drivers specific to them. This is part of a series of articles by Crowe partner Gerard O’Reilly that deal with a range of topics and challenges that owner-managed businesses face.
Employee retention – rewarding key staff
Key to ensuring your business value is maintained
A key factor in any business sale is who is going to run it for the new owners. If this is not immediately clear the deal is usually fatally wounded. There are degrees of concern though. A trade sale that can be quickly absorbed into an existing business has a lower level of concern than a sale to an investor or private equity who will be particularly concerned with the quality of management, their stickiness and their ability to step up to new roles.
Any plan to sell a business needs to understand the value good employees bring to the deal. Indeed, key staff may have greater opportunities opened to them within the larger organisation and thus welcome the opportunity with open arms. Many though consider it a potential challenge and take the opportunity to leave current employment.
Thus you must understand the value key people bring to a potential new owner and from this develop a plan to ensure continuity in this early part of new ownership.
From advising business owners over the years on selling their companies, this is a key first question and often one we look to fix very early in the process of building a valuable business. They key is aligning what is good for the business, the business owner and the key employees to create a win-win situation.
Through strong management the business grows and becomes more valuable, the owner can step back and be released from day-to-day responsibility and key employees are rewarded in the short-term with bonuses and in the longer term with accumulated value on exit.
So what are the key elements that make a good employee reward scheme?
- Stickiness. A reward scheme should ensure that value accumulates over a period rather than exclusively in the short term. Short-term reward elements are important, but assuming we are already rewarding people at a level which allows for a good standard of living, most people will be enthused by a reward system which creates a longer-term value.
- Tax efficiency. Assuming employees are reasonably rewarded, most will pay in excess of 50% on any marginal increase in income or bonus. This contrasts with capital gains tax at likely rate of 10% or 33% on share schemes. Also, structured correctly, these schemes can have a much lower cost of entry for each share purchased than their open market value, and thus can result in a higher gain on exit. Thus value is created for the employee at no cost to employer or employee.
- Control over exit. A small percentage ownership in a business means the employee does not have automatic control over their exit. This will be a decision for the majority shareholder. If required, a mechanism can be put in place which sets an obligation on the employer to repurchase. This is not necessarily ideal from an employer viewpoint. However, if you consider that the buyback is essentially bonus rolled up over several years and thus represents a deferred employee cost.
- Penalty for early exit. If the benefit is deferred in order to create ‘stickiness’ an early exit should not be rewarded. In most cases these benefits either lapse or are repurchased at little or no gain.
- Non-voting. Many of these structures involve some level of shares or share options where they share in the rewards on sale alongside existing owners. Many owners are concerned about loss of control in these circumstances and care needs to be taken to ensure that this does not arise. The simplest way is to make then non-voting shares. Voting shares have all the control and thus are the important ones from the recipient’s viewpoint. As an example of where this can cause problems, we recently came across a situation where a person held 2% of a family business. Not much power you would think. However, the two brothers, who were equal shareholders got into a dispute. Now suddenly this 2% becomes the controlling interest and when voting with either party they exercised control. So non-voting shares only!
In summary, there are reward structures that can be put in place to ensure that key employees are retained and long-term shareholder value is secured and grown.
Crowe partner Gerard O’Reilly manages our Business Value Builder Programme, a practical and effective programme for company owners to build lasting value in their business. Contact Gerry if you would like to find out how he can help you achieve your personal and business goals.
Read other articles in our Value Builder series:
Seven ways to create harmony in a family business