Financial Incentive Structure to Retain Key Employee Post Close

June 03, 2024

by a searcher in Nashville, TN, USA

Hi All!

I am ~3 weeks out from closing on a business where there is one key employee that has been with the business for ~20+ years. As both a token of appreciation for this employee's commitment to the business as well as a tool to incentivize retention post close, the seller wants to put some type of financial incentive in place. I feel incredibly fortunate to have a seller that wants to proactively put this in place and is willing to reduce their own financial profits to set the business/myself up for success but we are struggling to land on an approach. Any ideas of how to solution for this scenario?

A few considerations:
-Conceptually the idea is to structure something such that the employee receives payments over time based on how long he stays on post close
-I am using an SBA loan as well as a 15% seller note and we are in the closing process with the bank - whatever we land on priority is to not delay the deal/impact the SBA closing process
-The seller wants to limit tax liability where possible
-A few ideas that have been thrown out by the seller, each of which have drawbacks: putting a portion of proceeds from the transaction in escrow and signing an agreement with the employee with payout terms, reducing the purchase price and working something out such as an incentive plan for employee that I would payout over time (there is already profit sharing in place so this would be in addition to that)

Thanks in advance for any ideas!
-Iris

Reply by an intermediary
from Creighton University in Los Angeles, CA, USA

^redacted‌ To incentivize and retain the key employee post-acquisition, a retention bonus agreement is an effective solution here. Here's how it could be structured:

Retention Bonus Agreement - Determine the bonus amount based on the employee's annual compensation and criticality to the business, typically ranging from 25-90% of their base salary. For a long-tenured key employee, aim for the higher end, say 75-90%. - Structure the bonus payout over a###-###-#### month period after closing, with installments paid quarterly or semi-annually. This incentivizes the employee to remain during the crucial transition period. - Include provisions that if the employee is terminated without cause or leaves for "good reason" like demotion, the full unpaid bonus balance accelerates and is paid immediately. This protects the employee's interests. - The seller can fund the retention bonus from the sale proceeds by placing the full bonus amount in an escrow account at closing. This avoids impacting the purchase price or SBA loan. - Alternatively, you as the buyer can contractually agree to pay the bonus directly over time from operational cash flows. This reduces the seller's tax liability upfront.

Implementation - Draft a simple retention agreement outlining the bonus terms and have the seller and employee sign it before closing. - If funding via escrow, have the seller deposit the bonus amount into a third-party escrow account at closing using sale proceeds. - If you as the buyer are paying, include the bonus obligation in your financial projections and operating plan.

Would be happy to chat with you if you have more questions. You can schedule a time on my calendar here [https://calendly.com/dealwise/dealwise-30-minute-call]

Reply by a searcher
from Texas A&M University in Austin, TX, USA

I had the exact scenario for my business. I would be happy to chat if you have any questions; this is something I would have done very differently in hindsight. I did a retention bonus for our key employee - every dollar of the bonus paid to the employee reduced the seller note (the seller and I agreed to a bonus amount before close). This worked to retain the employee, but I wished I had put the burden of providing the cash for the bonus on the seller. The easiest way to do this (pending bank approval) would be to increase the working capital by the bonus amount. Effectively lowers the purchase price. I would include a point on the seller note that if the bonus is not paid due to your decision, the seller note will increase by that amount; however, if the employee leaves for any reason, you keep the cash, and the seller note stays the same. At close, you could transfer to an escrow account if that would make the seller feel more confident. My seller and his CPA could not figure out a way to do an escrow account without it having a negative tax impact.

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