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Extortion at Closing

At 2PM on Friday we told the two key managers (General Manager and VP of Sales) that we would be closing the sale of the business to a large regional pest control company in exactly one week.  The managers, understanding how important they were to the health of the company, soon realized that they possessed a tremendous amount of leverage.  Within 48 hours, they informed us that they would walk out the door unless we provided them a legal document promising a combined total of $500,000 at the closing table. At the start of the process, we knew that this could become a problem.  Because we didn’t have enough time to plan appropriately, we were very careful to make sure that the definitive purchase agreement signed by both buyer and seller clearly stated:

“Employees to be Hired.   Seller shall use its best efforts to encourage and attempt to secure for Purchaser the services of the selected Employees to be Hired from and after the Closing.”

According to the purchase agreement, all we had to do was use our best efforts “to encourage” and “attempt to secure” the employment of the employees by the acquirer. 

While this was all great in theory, when I mentioned this issue to the acquirer, their acquisition team immediately backed out of the deal invoking the protection of a tiny sentence burrowed deep within the purchase agreement (found in almost every purchase agreement I have ever seen): the Material Adverse Change clause, commonly referred to as the MAC clause, which simply states: 

The transaction shall close on Friday at 8AM provided that “there has not been any material adverse change in the business or business relations.”

The signed purchase agreement clearly stated that we didn’t have to deliver any employees… all we had to do was help the acquirer bring them aboard. Weren’t we protected by the “best efforts” language earlier in the contract?
 
At this point, it didn’t really matter what the contract said or didn’t say.  We had been working on this deal for the better part of a year, a huge amount of our client’s wealth was tied up in this pest control company, and he was being held hostage by two people with $100,000 per year compensation packages.  He had been closer than a brother with these two guys and had compensated them substantially for their work over the years, and now they had the nerve to demand a half million dollars from his retirement fund or destroy his company. 

Immediately after the meeting, the seller was overcome physically and spent the afternoon in the bathroom standing over the toilet.  As I waited for him, the lead negotiator from the acquirer’s team called me and said: “Paul, we are ready to move forward with this deal, but we need these two guys.  If we don’t have them, not only are we going to have problems running this branch, but can’t risk them quitting and taking our business with them.”

What were our options at this point?  Well, we could negotiate with the two pest control gunmen or we could file for an emergency injunction.  Bottom line, it was our interpretation of the purchase agreement against the acquirer’s, and like most disagreements involving contracts, the only way to settle it was to go to court and ask a judge to force the buyer to close the deal under the agreed-upon terms.  If the managers left now, not only would the deal crater, but the seller would lose his two most valuable employees.  Worse yet, if they left and began stealing business, it would be years before he would be able to sell this business at the same price, if at all.

What did we do, you ask?  Before I get into the outcome of this situation I am going to take a side-bar and discuss what you can do to avoid it altogether.

A lot of you who own pest control companies of substantial size have key employees, whether they are your top sales person, your president, your general manager, etc.  Because you run a service business, your people are extremely important to you today and will be just as important to whoever buys your business.  While I know 99% 100% of you reading this article would rather fall on a sword than sell your business to Terminix, I will quote Katrina Helmkamp, former President of Terminix, because she is right on when she said, acquirers “aim to hire as many of the associates of the acquired company as possible… [it] greatly enhances customer retention, strengthens [the] management pipeline and provides access to experienced technicians.” 

Ask Yourself
Whether you are selling this year or in 10 years, every one of you should take a step back and ask yourself

1.    Who are my key employees, and;

2.    What have I done to keep them from holding a gun to my head (or my family’s if I don’t make it) at the closing table.  

The first question is easy, the second, quite a bit more challenging.  Don’t just assume that everything will be OK because you’ve treated them kindly; the middle of a sale process is not the right time to have this discussion with your key employees.  No matter how smooth a sale goes, it’s a very emotional and trying time for any seller, and what you assume now will be put to the test during the sale process. At the end of the day, your key employees are going to think about self-preservation before they pat you on the back and send you out to Heaven’s Waiting Room Golf Course.  Especially if they think that you are walking away with millions of dollars selling an empire in which they toiled to help you build.  The closer you are to the eventual sale of the business to put a plan in place, the more leverage your key employees will have.  So planning is what we are about to do…

Show Me the Money

There are two circumstances which could quickly cause your key employees to start making nice with your competition: your death (or disablement) and the sale (or rumours of the sale) of your business.  One of the best things that you can do to mitigate transaction risk with your key employees is immediately sit down with them and discuss what would happen if you were to die. 

The purpose of this meeting will be to implement a “Stay Bonus” plan that will not just keep them around it will also keep them motivated in the event of your death, incapacitation or the sale of the company.  I have seen this situation play out many times, and I can tell you, these stay bonuses don’t have to be big sums of money to keep the employees around and resistant to the siren calls of your competitors, who will definitely be calling them. 

A stay bonus is very simple to set up and may be the key to holding your business together during a sale.  The majority of stay bonuses are one page agreements that say something like:

“Jim Smith, General Manager, will be paid a cash bonus of $x thousand on the one year anniversary of (1) the death of John Q. Owner; (2) the incapacitation of John Q. Owner; or, (3) the sale of the company, provided that Jim Smith ….” 

The “provided that” part would usually include duties and have some sort of measurable performance metrics.  The stay bonus should never be paid at closing (though some do provide for a portion to be paid at closing) because the majority of pest control acquisitions are subject to some sort of hold-back, meaning that the bulk of the purchase price is paid up front and the rest is “held back”, usually for one year, subject to certain conditions such as employee and account retention, etc.  You want your key guy to get paid when you get paid.

A Fancy Trick
Some owners take the stay bonus one step further to increase the selling price of the business.    We have a current client who has decided that he doesn’t want to give any stock to his key man, he does however, want to motivate this guy to help him build value in the business.  The client is planning to sell the business within the next three years.  So in lieu of giving stock to the Vice President, he established a separate informal partnership with him.  He engaged us to determine an appropriate potential strategic value for the firm three years from today and set up the partnership that stipulates that the manager will receive 50% of the proceeds above this projected future value.  For example, let’s say that his business is worth approximately $6 million today, and we’ve estimated the value, based on historical growth and projected market conditions to be $7 million in three years.  If the manager is able improve performance and increase the value of the business and it sells for $8 million, the owner will receive $7.5 million and the manager $500,000 (half at closing and the other half one year from the closing).  What a powerful way to motivate and compensate someone that you rely on, while not giving up any ownership in the company and creating extra wealth for yourself in the process. 

… Back to the Story
So what did we do?  We created a stay bonus one week before the sale of the company, payable at the one year anniversary of the closing when the seller was to receive his holdback.  We didn’t pay $500,000, but we paid much more than we would have, had we been able to plan a year before.  The stress sent our client to the hospital and I missed our family vacation, but we got the deal done and everyone is happy.

Do you have key employees?  Give us a call today at 215-268-7586 to discuss how our innovative investment banking team can help you structure your business for maximum value and minimal risk.

Interested in learning more about valuation and mergers & acquisitions in the pest control industry? Subscribe to Potomac Company commentary and research on the Pest Control Industry.


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