When valuing a closely held business, I frequently pose the following question to the business owner: what do you think the business is worth without you? A similar question can be asked in regard to key employees: what is the business worth without your key employees? If they are critical to the success of the business their possible departure represents a risk to the business.
There are legal steps that you can take to protect the business from the departure of such an employee – you can have the employee sign a non-compete agreement. However, key employees can always leave and take a job or start their own business out of your area. Much more effective is to establish a key employee incentive bonus plan that will encourage your key employee to remain with your company and increase your profits!
Successful key employee bonus plans tend to share certain characteristics:
- Are specific and are in writing;
- Are tied to performance standards that are within the employees scope of work;
- Give the employee an opportunity to make a substantial bonus;
- Handcuff the employee to the Company.
The plan must set out clear standards for the employee to meet and must be clearly explained. The employee must thoroughly understand the plan and understand how she can earn the bonus. This is best done in face-to-face meetings.
The bonus is tied to objective standards that are tailored specifically for the employee. These bonuses are most commonly used for sales personnel who are given specific sales objectives, but they can be designed for any type of management employee. Frequently the owner will consult with his advisors to determine appropriate standards – revenue, net income, cost containment. These standards might pertain to the employee’s specific department, the company overall, or a portion of each. The standards must be ones that are within the employee’s ability to achieve and that increase the overall performance of the company.
The more difficult problem is when the owner is “key” to the business and can’t easily be replaced. We see this most frequently when the current owner was the founder of the business and retains the principal customer contacts or the “know-how” essential to the business.
This situation is a good example of why, when I ask the business owner “how much is the business is worth without you” the best answer is “it doesn’t matter if I am running the business or not”. This means that the business will have just as much value in the buyer’s hands as it does in the seller’s and it is relatively easy to sell the business. However, we are frequently presented with a situation that is not ideal. The art of the exit planner is to be able to develop solutions that will work in the “non-optimal” case.
This blog is an excerpt from my article featured in the September 2016 issue of Business2Business magazine.