Planning for the ultimate exit for your business involves a lot of moving parts.
A bulk of your efforts should ideally be positioned around maximizing your business value for its sale.
That means ensuring your key people can remain key for your buyer. In this article, we’ll help you understand how employee vesting periods can mitigate risk to your buyer, what the best case and worst case scenarios are and how to ensure your plan is compliant to make for a seamless exit from your business.
What Is A Vesting Period?
A vesting period is a period of time in which an employee must work for an employer to receive some kind of benefit. A deferred benefit. This is not only a benefit to your key employees but to your business continuity – from being the business owner to transitioning away from the business.
Employee Vesting Periods Mitigates Risk To Your Buyer
First and foremost, you need to ask yourself this question: Does my buyer or my ideal buyer want to keep my employees or start from scratch? Or do I even care?
If the answer is they want to start from scratch with their OWN employees, this article isn’t for you.
But, for that business owner who wants to sell their business to a buyer who wants to keep their employees in place, keep reading.
While retaining your key people is just one of the ways to maximize your business value, it’s arguably the most powerful tool you have. That’s because your people are what drive your business growth, making this factor very relevant to your potential buyers.
Just like selling your business is a big undertaking, buying a business is as well. And, from a buyer’s perspective, knowing you potentially have vested key employees through the purchase of the business mitigates much of the risk associated with buying a business. We can’t emphasize this point enough!
The right vesting period for this kind of retention strategy is ideally set up somewhere between 8 to 10 years, with the last two years under the new owner. If the timeline for the exit doesn’t match up with 8-10 years, we go with the 2 year post sale timeline. A strategy like this is a huge benefit to your buyer for a few reasons:
- Your key employees know more than the new owner
- The new owner doesn’t have to spend time finding employees
- Company culture is maintained
- Productivity remains steadfast, and
- There are overall less unknowns for the new owner
Now, once you exit your business, the plan transfers to the new owner and can be funded at the original level or increased slightly or at whatever level the new owner wants.
There are NO LIMITS!
A post sale increase can have incredible effects to the new company culture – an opportunity to take advantage of and celebrate the key employees.
Best Case Scenario With The New Business Owner
Aligning your exit date with employee vesting periods sets your buyer up for a best case scenario when it comes to your people. With a best case scenario, your vested employees would stay with the company for 24 months after the sale and receive their reward.
Even if the vested employee doesn’t necessarily like the new business owner, it should be well worth it for them to stay for another two years through the transition. Both parties will benefit, good or bad, from this very quick 2 years. Just these two years does wonders for your buyer in terms of the learning curve and helps prevent the employee from making an irrational decision to leave the company without really knowing how things might work out.
What’s even better?
The employee and new business owner extend or draw up a new retention plan well into the future. In fact, the new owner could even increase incentives after the sale for an even smoother transition. Keep people after a change of control, that’s a win!
Worst Case Scenario With The New Business Owner
Now, worst case scenarios are never fun to imagine but doing so helps you better prepare and plan. With a worst case scenario, your key employees might simply not like the new owner and very well may choose to part ways, regardless of the incentive. This is rare with the right retention plan, but it does happen.
Anytime there is a triggering event, like change of control, one of two things can happen for the protection of your employees and your business.
- Advance the incentive roll out but at a smaller amount (20% or so), or
- The employee leaves but with no incentive or bonus whatsoever
This is where options in the employee agreement come into play and there are compliance issues that have to be recognized. You might be promising a substantial benefit if they remain for the entire vesting period BUT they have to stay and they can’t go to another competitor even if they leave before vesting is complete – a traditional non-compete.
We often see this with a poor culture. Golden handcuffs if you will.
But, let’s be clear, no one wants to be handcuffed and no one wants to be retained.
The psychological impact of how these plans are delivered matters, but suffice it to say, your best employees know they are key and using terms like recognition planning and reward planning is what we use to deliver the best messaging.
The worst case scenario for the new business owner is making it too easy for key employees to leave when, if given enough time, things could work out for both parties. The hope is that, if the culture is right, the new owner will continue to fund and roll out your curated vesting periods.
Employee Vesting Plans Must Be Compliant
Regardless of the outcome of these strategies, all employee vesting plans must be compliant. Agreements are put in place to protect the owner, buyer, and employee and should cover varying outcomes.
According to Section 409A of the United States Internal Revenue Code, nonqualified deferred compensation paid by a “service recipient” to a “service provider” by generally imposing a 20% excise tax when certain design or operational rules contained in the section are violated.
So, while it’s flexible to extend or advance vesting periods to match your expected retirement date, pending legal work to do so, you don’t want your plans to be governed by this as the penalties can be severe.
Align Your Exit Date With The Right Retention Strategy
Spending money for retention or reward plans can help you receive a higher sale price for your business. This new and improved sale price can be substantial when you think about retaining several employees over an 8 to 10 year period.
But, implementing the RIGHT retention plans matter here. With careful planning and consideration when it comes to aligning your exit date with employee vesting periods, you can do what’s in the best interest for your business and its employees.
To start proactively addressing these aspects for a smoother sale, talk with us at Consolidated Planning.
2024-169622 Exp. 2/2026
Guardian, its subsidiaries, agents and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. The information provided is based on our general understanding of the subject matter discussed and is for informational purposes only.
This material contains the current opinions of Mike Thompson and Consolidated Planning only. These are not the opinions of Park Avenue Securities, Guardian, or its subsidiaries.
