02/05/2018

What it Takes to Acquire a Committed Team, Not Just a Business in M&A

Talent, key employees, dream teams. There are no rows in the balance sheet for these assets.

A company’s books will tell you how many people it employs, but talent is not reflected in multiples or enterprise values. Despite the fact that retaining key personnel should be on the buyer’s mind, it is usually off the negotiation table when the terms of the deal are agreed. Purchase price adjustment mechanisms tied to retaining ‘dream teams’ remain rare.

The question then is how buyers can ensure that they get value for the money they invest when the business or company they are acquiring is dependent on certain key employees. This question should be at the top of mind of any buyer today, since acquisitions are increasingly less about acquiring tangible assets and more about acquiring the right people.

A share or business purchase agreement may include a condition precedent stipulating that the key employees must still be employed by the target on the closing date in order for the buyer to have an obligation to go ahead and complete the deal. But what happens after the deal is completed and the seller is gone?

As legal advisors we strive to guide our clients to find the right path to ensure the key personnel stay on board, and committed, also after the merger or acquisition.

Successful Integration Means Leading People through Change

We spend a lot of time on due diligence in order to identify risks. When it comes to the workforce, we tend to focus on historical and potential future liabilities involving direct costs. Once the investment is made, however, the most significant risk lies in successfully integrating and leading people through the change that a merger or acquisition inevitably entails.

In the due diligence review, we check that agreements with key employees contain sufficient non-compete and non-solicitation clauses preventing them from transferring to a competitor not only during their employment but also for some time thereafter. If they decide to leave, the agreement should prevent them from soliciting other colleagues and potential talent to leave with them.

We do the same to ensure that these people are bound by adequate confidentiality and IPR clauses, which provide protection against sensitive information leaking out and know-how and technology ending up in the wrong hands. This is all well and good, but is just the first box to tick.

Acquiring a Team, not just Business

A Transaction Bonus Alone Won’t Save the Day

In order to motivate key employees to put in all the extra work needed in a sales process, the seller may already have incentivised them by agreeing to pay a one-time cash bonus once the deal is signed. Transaction bonuses may, further, be agreed to become payable only if the key employees, either individually or as a team, remain employed with the target for a certain time after the deal is closed.

A transaction bonus can also be crafted as security against potential later dismissal by the new owner. If so, it becomes payable if the key employee is served notice before a certain date. Consequently, transaction bonuses are often paid by the seller.

At the end of the day however, no transaction bonus can provide much comfort to a buyer regarding the future. In fact, a very significant transaction bonus may have quite the opposite effect, in particular if the employee does not have sufficient clarity about the future.

Recognising Key Employees and Keeping Them On Board

Perhaps one of the key questions is whether we are paying enough attention to who the key employees really are. Key employees are often defined as the executive management. While they are certainly essential in most businesses, buyers should also be looking in less obvious places.

It is important to look for employees who have skills that could be decisive during the integration phase or crucial for delivering long-term targets. The back-office IT team may be irreplaceable, because they are the ones who will be responsible for the business-critical IT carve out that lies ahead after the merger.

Once you have truly identified your target’s key employees, you can consider how to incentivise them. It is generally worth looking at a mix of short- and long-term target-based bonus arrangements.

A traditional approach is to offer key employees equity. However, ownership is not for everyone. Some employees would still prefer to just collect a paycheck. A hybrid form, called virtual stock, could be a good alternative for these kind of employees. Virtual stock can provide the financial upside equity offers, though it lacks the other rights a shareholder would have, such as vote rights.

Interestingly enough, there are some surveys showing that there are a number of soft incentives that may be much more effective—and much cheaper—than money in retaining key people after the deal is closed.

The McKinsey study linked above describes a European industrial company that applied a mix of non-financial and financial incentives during a recent reorganisation. That company found that it required only 25% of the budget that had previously been spent on a broad, cash-based scheme.

What the McKinsey study indicates is that while money is an important factor in retention, it won’t do the trick alone.

Clear Future, Happy Staff

M&A veterans tend to focus on keeping talent. We recognise that employees stay when they are engaged, paid well, mentored, promoted regularly, respected and trusted. Ultimately, what employees want most of all is clarity about their future. This requires communication from the employer.

Praise from managers, attention from leaders, promotions, opportunities to lead projects and chances to join management or mentoring programmes do not cost much, but can be very effective motivators. Non-financial incentives take a bit more time, attention and care to put in place, though, which is perhaps why they are not always at the top of the list in the aftermath of a hectic deal.

Financial incentives can and should be used, but they need to be designed carefully. For example, it is essential to ensure that a substantial part of any incentive is paid only after the merger or acquisition and when certain performance targets have been met.

It may also be worthwhile for a buyer to stop for a minute and consider whether it is isolated individuals that need be retained or actually a groupof individuals that need be retained as a team. If the latter, the financial incentive can be tailored with criteria committing the whole team.

Finally, try to avoid last minute incentive arrangements, as they actually tend to dilute trust and appreciation than create genuine commitment. As always, timely communication is the key when dealing with people.