In almost every sale engagement, it will be necessary to have an employment agreement for the exiting owner, for some time period post sale. Before even signing the initial letter of intent, it is prudent to have certain features of that agreement-to-be articulated clearly between buyer and seller.
Period of time-
Sellers will want to know what the expected minimum period of time will be for their employment, post close. In some instances, it may be as short as three to six months. Usually those are circumstances where the successor CEO is already identified and knows the business, and probably the company, well. The time to be worked during that transitionary period may also be limited in those cases, to adequate amounts of time to consult with the successor and to transition relationships.
More commonly, the buyer will seek a minimum transition period of a year or sometimes even longer. Buyer and seller should articulate the plan for transition clearly so that buyer and seller can work together effectively to get replacement resources in place, and to transition duties and provide training.
In some instances, the duration or transitionary time may not be firmly established as of the closing. Buyer and seller should at least discuss expectations, and the “notice” period be firmly established, if the seller decides to leave later. In the average situation, the seller may be required to give perhaps 90 days’ notice. However, this will depend in part on how strong alternative resources are to keep the company healthy throughout an exit period. We have seen situations with as little as 30 days’ notice, usually with a minimum time for owner continuation before such notice would be permitted, and other situations with as much as six months.
Salary levels should be clearly established in advance of a closing. Benefits too should be stated, particularly if some are beyond the normal benefit package of other employees within the company. If there is major bonus element anticipated, that too should be articulated clearly. If a company car is to be provided, that should be mentioned. Additionally, the set “rank”, title, or or role within the company should be articulated. We have had situations where the owner’s role changed fairly dramatically post close. For example, owners who are not enthused about certain financial or administrative duties may opt out of those if they continue to work. (One of the substantive benefits of sale may sometimes be to transition away from least favorite roles, and to have buyers undertake replacement for those duties.)
A non-compete agreement will usually be required upon exit of the owner. Terms and duration of such agreement should be outlined in advance of initiation of the relationship. A post-employment non-compete commonly applies to activities or companies that would be competitive to the seller company. However, sometimes a buyer may wish to expand that range to also include activities of other companies owned by or affiliated with the buyer. Duration of that post-employment non-compete should also be established. The shortest likely would probably be one year. However, we have seen many that extended three years.
Many of the equity fund buyers of companies today may propose some portion of ownership to be retained by the seller post-close. These can be wonderfully productive arrangements, for both buyer and seller. However, if the owner intends to keep an ownership stake post-closing, it is also important to talk through the eventual liquidation of that stake, should he decide to leave.
Sometimes a seller may prefer to hold stock until the buyer re-sells. But more commonly, the seller prefers to exit when he stops working in the company. Buyers usually are willing to commit to some buy-back if the owner exits, at some formula level. The payment that would be required is usually based on the same multiple as the purchase price, applied however to the THEN current earnings of the company. This sort of arrangement allows the owner to benefit from continued growth during his tenure, but still provides for his later “cash in” of his stake.
Buyers often worry about the magnitude of a cash requirement to cover this at some later time and will argue for some limited time period to repay this amount. If the owner has kept 10% or less, buyers are generally OK with paying in full soon after an exit. If the percentage share is 20 or 30%, they will probably want some time to cover it. Normally we have seen payment required a bit each year, with perhaps two or three years to accomplish the buyout in full.
Any seller ownership of stock should be purchased at the same cost as the cost of equity input by the buyers. We have seen situations where buyers propose to purchase a majority percentage of the stock but ask the seller to hold some small percentage of his stock, without selling it. A buyer will put in somewhere between 20-50% of the overall cost of the company, as equity. The remaining cash paid by the buyer will be financed, by debt the selling company will take on. When, instead of holding a portion of the stock, the seller sells all, but then repurchases at the same cost as the buyer equity, he thus has far less invested. For example, in a $50M deal, where the owner is to re-invest in 10% of the buyer input, the stock (or assets) would first all be sold, with the seller receiving all of the $50M first. THEN he would reinvest. If the buyer were investing say 50% of the cost, the buyer would then be putting in $25M, and get $25M of the seller’s proceeds from loans by banks. In this example, the seller who wanted to hold 10%, would put in 10% of the buyer’s equity, which in this example was $25M. Thus the seller would receive $50M, and would reinvest $2.5M to continue to hold 10%. (Much better than if he had held 10% of the original stock, which would have only brought him $45M.)
Also, if an ownership stake is to remain in place, it is important for the agreement to stipulate that only one class of stock shall be in place, and that seller rights in total can’t be less than rights for any other shareholder. We once had a client who accepted stock, just a few months after his original close. The issue of “class” of stock was never discussed. He was free to not work at the company already, but he believed in its potential and enthusiastically put money back in. A year or two later, the company got into trouble and failed. They buyer was able to salvage a large amount of the investment with their “Class A” stock. The seller got almost nothing for his then “Class B” stock.
Many sellers would be reluctant to move geographically, within the new relationship. If that’s the case, prohibitions should be established about potential transfers within the organization.
Although mentioned above briefly, it may be important to delineate changes that may be made in connection with the owner’s role for the company. We had one situation where our owner seller had taken a significant “earn-out” in the deal, and shortly after closing, the buyer began offering competing jobs in other organizations they owned, to his top people. In that case we were able to come back to the buyer, and negotiate a “guaranteed” earnout, in exchange for letting them take some of the company’s best people. Our client was pretty happy with the outcome in the end, but it was unnerving for a while.
The more you can discuss and commit in writing to mutual expectations for employment and later exit, the cleaner documentation of the deal will be, and the greater the likelihood for successful closing and for happy continuance post close. It’s worth the time and effort to discuss these things in advance, and can be material to the ending output for owners.
Questions? Email Deborah or call 314-991-5150