May 26, 2016
Keeping employees motivated is often an essential factor in a company’s success and indeed in its continued growth. If you are a business owner who is contemplating selling your business, having a stable and motivated workforce will likely underpin the attractiveness of your business to potential buyers.
Exactly how and when to incentivise key staff is an important consideration for a company. There are a number of different ways to approach employee related incentives. If you wish to give certain staff shares in your business you may choose to do so through a tax efficient share option scheme such as The Enterprise Management Incentive (EMI) scheme, provided certain criteria are satisfied. To be eligible to operate an EMI scheme, the company must, among other things, be independent, have gross assets of £30 million or less, not work in one of the excluded activities such as property development, banking, farming, ship building or providing legal services and have fewer than 250 employees. An added benefit to an EMI Scheme is that it provides easier access to Entrepreneurs’ Relief (10% tax rate) to EMI option holders who sell their shares.
However it may not always be appropriate to offer share options to employees and an alternative incentive scheme, such as a cash based bonus scheme, may be more suitable. Keep in mind that the scheme that is chosen may have particular employment law or tax consequences for your company and indeed the individual employees. Whichever scheme is right for your company, it is essential to consider these issues as early as possible and plan ahead.
If your company satisfies the relevant criteria and you wish to put in place a share option scheme such as an EMI scheme, this is ideally done when your company is young and the market value is therefore likely to be relatively low. This should enable a company to support a low exercise price. Once you either take investment, are generating significant profits or start receiving offers from potential buyers this will drive up the market value and consequently the exercise price you will be able to set.
Unfulfilled promises can spell trouble down the line
If you make promises to staff it is important that these are followed up and documented in the appropriate manner. In a recent deal which our Corporate team advised on, it was discovered during due diligence that the founders of the target company had previously promised shares in the company to a few key employees. Unfortunately, these shares were never actually issued. The unfulfilled promises made to these strategically important employees resulted in the deal structure having to be altered to allow for them to be sufficiently compensated for their contribution to the business up to the point of sale. It was also considered necessary to provide such employees with an incentive to continue to drive the business during the earn-out period and provide stability post sale.
It is not hard to imagine how similar circumstances (i.e. an apparent disparity between what certain employees of the target have been promised and what they have actually received at the point of agreeing sale terms) could lead to concerns over a buyer acquiring a potentially disgruntled and unstable management team resulting in either a re-evaluation of the purchase price or even the deal as a whole.
Incentivising key staff during an earn-out period
Business owners often think about incentivising staff only up to the point of a sale of the business. However, as mentioned, it is common in many exits for a period of earn-out to be included in the deal structure. If this is the case it may be worth considering a two stage approach to your incentivisation plan: (1) pre exit, when you are focused on growing your business and making it attractive to potential buyers; and (2) during an earn-out period.
Keeping the key management and employees’ interests aligned with the selling shareholders for the duration of the earn-out may be vital in ensuring the stability, drive and commitment necessary to maintain the performance of the business and consequently meet the earn-out targets. The continued stability of the business post sale will also be an important factor for any buyer.
One approach that we are seeing more frequently is to implement a cash bonus scheme related to the earn-out targets, albeit there are a number of different options to be explored.
More unusually, we recently came across a deal where it was agreed that someone from the buyer’s team was also financially incentivised by reference to the target meeting its earn-out milestones. Having someone on the buyer side with “skin in the game” was an important feature of that earn-out negotiation and this concept broadens the category of individuals who it may be beneficial to incentivise.
There is no one-size-fits-all approach to this but proactively considering the range of employee incentives available is an effective way of ensuring your team is driven to maximise the value of the business both pre and post sale.
“This article is for information purposes only and does not constitute legal advice”.
Louise Eldridge, Partner and Chris Devlin, Associate, Bristows LLP.