If you are a business owner, your largest asset is very likely your business. While employees plan for their retirement by saving, for a business owner there is so much more.
Are you critical to the success of your business? I bet many business owner proudly answer that question with a resounding yes. But if selling your business is a part of your retirement plan, you have to rethink that strategy…now. No one wants to buy a business if the critical asset is not included in the deal. Think about it.
Buyers will pay much more for a business where the owner’s role is less significant.
To get the best purchase price for your business consider transitioning into retirement by gradually delegating important functions to key employees and motivating them to stay through a sale. As an aside, your key employees may be the best candidates to buy your business.
Who are your key employees? To make this change strategically, business owners should first consider who their key employees are. Key employees are those employees that think like a business owner. They are committed to the success of the business and are motivated by financial rewards. Key employees thrive on new opportunities and responsibilities. Unlike many very good employees, they are not simply satisfied with interesting work, good pay, and job security. Key employees want more.
What functions should you delegate? The lowest lying fruit are those portions of your business that you “know” could add value, but you just never have the time to get to them. It may be managing the sales force, servicing a new industry, developing an ancillary product, or many other things.
How can you motivate and retain key employees? The simple answer is: 1) pay them to add value to your business, and 2) defer a portion of the payment over time to motivate them to stay.
Paying a key employee to add value to your business means precisely that. The bonus portion of their compensation should be very closely tied to their success in adding value to the business. The potential bonus must be large enough to provide incentive. A rule of thumb is for incentive compensation to account for at least 10-20% of an employee’s annual compensation. Some business owners are short sighted and reluctant to offer performance bonuses because of the cost. But keep in mind you will be delegating more work to this key employee and more importantly, if the employee adds value to your business and receives a relatively small portion of the increased value in return, you are far ahead of the game.
An effective incentive plan often provides for some payment in cash, perhaps annually, shortly after it is earned and a portion deferred with continual vesting. This structure provides incentive to perform and to stay.
Example. Assuming a key employees increased the value of your business by $500,000 in a year and earned 10% of that increase or $50,000. A plan could provide that 50% or $25,000 of the bonus is paid in cash in the year it is earned, and the balance of $25,000 is deferred with 20% vesting in each year for 5 years. As years pass the key employee will be partially vested in five years of performance bonuses. Assuming the same performance described above for 5 years, the employee would walk away from approximately $75,000 if he chose to leave, which is incentive to stay. Under this example, by incentivizing your key employee to aim for your target of adding value to your business, you increased your “retirement plan” by $2,000,000 in five years.
An additional benefit of continual vesting or “golden handcuffs” is that the obligation to pay a performance bonus can provide collateral to enforce a confidentiality, non-compete and non solicitation agreement. These agreements are otherwise difficult and expensive to enforce.
Go ahead…loosen the reins and harness the power of your key employees to add value to you business and “retirement” plan.
For legal counsel in structuring and drafting incentive bonus plans uniquely tailored to your business, please contact Ernest Closser, Esq. at email or 215-736-2521.