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Deal Killer #4: The Failure to Preserve a Company’s Most Valuable Asset
Shirley Locke, ace Exit Planner, listened patiently as Chuck, a business owner and new client, proclaimed his eagerness to sell his company based on an unsolicited, yet attractive, offer he’d just received. Like many owners Chuck felt ready to exit today and was certain that his company was as ready as he was. His had only one question for Shirley, “Can you look over this Letter of Intent (LOI) before I sign it? It seems fine to me.”
We’ll follow Shirley’s lead and save the discussion of the issues unique to Letters of Intent for another time and move instead to her first question: “Can you tell me a bit about your company?”
Shirley quickly zeroed in on the fact that Chuck’s company had experienced extraordinary revenue growth due in large part to Chuck’s decision (four years earlier) to hire a “next-level” management team. [1]
Shirley then asked, “Chuck, I’d like to see the Covenant Not to Competes or Non-Solicitation Agreements that your new managers signed as part of their employment agreements. Do you have them with you?”
“Well no, because they don’t exist,” Chuck admitted. “But that’s not really an issue. I pay this team very well and they’re very happy.”
“I hope they are,” said Shirley, “but let me tell you the story of another owner who thought the same thing about his team. I heard this from an investment banker, [2] and I think of it as ‘The Case of the Blackmailing CIO.’” Shirley had heard this story when she attended Boot Camp for Advisors™ from BEI Member and investment banker Kevin Short:
This owner was a week away from the sale of his company for $10 million when (at this very late stage of the game) the buyer met with each of the key managers to reassure them that they’d be retained by the new owners at their existing compensation levels. At its meeting with the Chief Information Officer, the buyer was lavish in its praise of her performance and indicated how important her continued involvement was to the company’s future success.
When the buyer then asked her to sign a covenant not to compete before the closing date, the CIO asked for a short break and headed straight for the owner’s office. She reminded him that she’d built (and maintained) the company’s data warehouse and custom app allowing customers to access and change orders (one of the company’s competitive advantages), and ever-so generously consented to wait patiently until the closing date “to collect her $1 million bonus.”
This owner paid the ransom because he knew that if his CIO, who alone managed the company’s intellectual property, left the company, the buyer would likely scrap the deal. If the buyer did subsequently come to the closing table, it would reduce its purchase offer by far more than $1 million.
Chuck immediately understood the morals of Shirley’s story, as will your clients. First, the story illustrated that replacing an owner as the center of the company with a management team is a critical component of creating transferable business value. As you know, buyers insist on this. Owners also understand, but can ignore, that with the relocation of management to the hub of the business, there is an accompanying threat: management team members can leave the company, compete, and take with them important relationships, customers, employees, vendor relationships and more.
Chuck realized, a little late in the game, that he should do all he could to prevent employees from harming his company, or his ability to exit, by creating enforceable covenants and agreements.
Shirley gently suggested to a somewhat chastened Chuck that he meet immediately with best-in-class legal counsel to create the necessary documentation.
We find that it is unusual for owners to create the safeguards necessary to protect their companies. It is equally unlikely that owners’ current advisors will suggest that they do so. As a result nothing is done to protect the company’s most valuable asset, but quite a lot has been done to create a potent Deal Killer.
If you haven’t already discussed tying key employees to their employers with stronger bonds than feelings of good will, we suggest that you describe to your owner-clients the dangers of proceeding without such protections in place. Use Kevin’s story above if you don’t have one of your own. And, if a client’s legal counsel does not have expertise in employment law, it is your job as their Exit Planning advisor to recommend one who does.