Retaining Key Employees in M&A Transactions

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For potential buyers in a business merger or acquisition, the loss of key employees is a significant risk. That’s especially true in small- to medium-sized businesses, where critical roles and proprietary business insight can be concentrated in a few individuals and the impact of a key worker’s departure can be magnified.

As a firm that’s spent decades guiding buyers and sellers through high-stakes business transactions, our team at Hendershot Cowart P.C. knows retaining key employees can be a critical component of post-closing success, especially in the small- to medium-sized business space.

Retaining Key Employees Is Critical to A Successful Acquisition

As a buyer, your due diligence should include assessments of employees whose work, presence, or pre-existing relationships bring value to the target business and your objectives. These may be top performers with a large impact on customers or earnings and revenue or they may be engineers, supervisors, or other players deeply involved in critical projects.

There are several key reasons to prioritize retaining key employees during a business acquisition:

  • Maintain Institutional Knowledge and Expertise: These employees often possess critical knowledge about the acquired company's operations, customers, and products. Losing them can disrupt operations and hinder the smooth integration of the two businesses.
  • Preserve Culture: Key workers may also have outsize influence over company culture and can help maintain it amid times of transition.
  • Protect Intellectual Property: There are laws and legal agreements to protect trade secrets; however, the owners of your target company may not have those agreements in place. Retaining employees with access to confidential information may make more sense than pursuing litigation if trade secrets fall into the wrong hands.
  • Uphold Client and Customer Relationships: Key employees often have established relationships with clients and customers. Their absence can damage these relationships and lead to a loss of business.
  • Maintain Morale and Productivity: A mass exodus of key employees can demoralize the remaining workforce and significantly impact overall productivity, especially if these employees serve as mentors.

Identifying Key Employees

There’s no clear-cut formula for what makes a “key employee.” Those deemed “irreplaceable” by a seller for their reasons may not be for yours. As such, you’ll want to clearly define the criteria for who falls under this category, considering not only skillsets, institutional knowledge, and proximity to trade secrets, customers, or culture, but also the impact of any potential departure.

Here are some questions to help identify key employees:

  • Who are the top sellers or producers?
  • Who are the essential product developers or service innovators?
  • Who could do the most damage by working with a competitor?
  • Who would be difficult to replace, either due to a unique skillset or scarcity in the market?
  • Who are the key relationship managers for clients and vendors or suppliers?
  • Which employees consistently receive outstanding performance reviews and earn the most competitive salaries?
  • Are there employees or executives leading mission-critical projects?
  • Are there “influencers” or “culture-keepers” in the organization who can influence retention? Look beyond executives and those in management; internal influencers are present throughout the organization.

Conversely, this may also be a good time to identify employees you do not want to bring forward into the new organization and plan for their exit.

Once you identify key employees, what next?

Consider these legal strategies for keeping workers you can’t afford to lose:

Before the Acquisition

Some pre-acquisition steps to take include:

  1. Transparency and Communication: Keep employees informed as early as possible about potential acquisition talks to control the narrative. Explain the rationale behind the deal and how it might impact the company. Open communication fosters trust and reduces anxiety.
  2. Highlight Opportunities: Frame the acquisition as a positive development, showcasing potential growth opportunities, career advancement possibilities, and access to new resources.
  3. Targeted Retention Packages: Consider offering competitive retention packages to key employees. This could include signing bonuses, stock options in the acquiring company, or guaranteed employment terms for a set period.

During the Acquisition

As the deal heats up, so does the potential for problems with key employees. Uncertainty about the future can influence high-value employees or executives to look elsewhere for opportunities.

Mitigate these risks with these strategies:

  1. Maintain Open Communication: Combat rumors and misinformation with regular updates about the acquisition process, addressing employee concerns and anxieties openly.
  2. Minimize Disruption: Strive to maintain a sense of normalcy in the workplace as much as possible. Avoid drastic changes to employee routines or benefits.
  3. Involve Key Employees: Include key employees in the decision-making or due diligence process. You may gain valuable company insight and win an advocate within the organization at the same time.

After the Acquisition

After a business has changed hands, continue to proactively engage key employees.

After the acquisition, focus on:

  1. Building Trust. Your new employees will be on the lookout for indications that pre-acquisition transition plans will be carried out as communicated. Stick to the plan or take the time to explain the need for variations to build trust in the new owners.
  2. Making Sure Employees Understand New Terms. If the previous owner did not require non-compete, non-solicitation, or confidentiality agreements as a condition of employment, you likely will. Help employees understand the rationale behind the request and the new terms. Soften the addition of restrictive covenants with new benefits such as flexible working arrangements or professional development opportunities.
  3. Succession Planning for Key Roles: It’s inevitable to have some employee turnover after an acquisition. Identify essential personnel and develop contingency plans. This could involve designating temporary replacements or outlining a training process for existing employees to step up.

A Note on Employee Agreements and Acquisitions

Employees of your target company may see a change in ownership as the ideal time to leave and start their own business or go to work for a competitor. For this reason, reviewing the employment agreements and restrictive covenants in place is an integral part of the due diligence process.

If non-compete, non-solicitation, and confidentiality agreements are not in place, include updated and signed agreements from key employees as a closing day deliverable.

Texas courts will allow companies to renegotiate employment terms when a company changes hands, especially if the change does not create a hardship for the employee.

Which Employees Should Sign a Non-Compete?

To be enforceable in Texas, a non-compete agreement must be reasonable in duration, geographic area, and scope of activity, among other requirements. If a court deems any of these elements to be broader than necessary to protect the interests of the business, the court can reform or nullify the agreement.

Make sure, when selecting which employees to restrict with a non-compete agreement, that you are protecting the legitimate interests of the company. If you cast too wide a net, a judge may reform or nullify the agreement.

For example, you should not restrict an employee from working within the entire state of Texas if the company’s territory is limited to the Houston area. Similarly, you should not try to restrict future employment opportunities for an employee who does not have access to proprietary information. Non-compete agreements must protect a legitimate business interest, such as trade secrets, confidential information, or business goodwill, and Texas courts are given wide latitude to reform non-competes the court believes are overly restrictive.

How Hendershot Cowart P.C. Can Help

Don’t underestimate the trauma and uncertainty a change in ownership can cause to a target company’s workforce. Talk to the M&A attorneys at Hendershot Cowart P.C. for retention strategies that protect your growing business.

Hendershot Cowart P.C. is an award-winning law firm with decades of experience counseling small- to mid-size business owners, executives, and investors across a range of industries through mergers and acquisitions and other business transactions.

If you have questions about our team and how we can help, give us a call at (713) 909-7323 or contact us online.

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