Preparing Your Business for Sale – Dealing With Employees

By Robert W. Malone

There are many aspects of preparing a company for sale, but none more important than properly dealing with the company’s employees. After all, for most businesses, their most valuable asset is their workforce.

The first thing that a prospective seller should do is inventory and examine the company’s existing agreements with its employees. Do those agreements adequately protect the company’s confidential and propriety information, intellectual property, customer, supplier, independent contractor and employment relationships? Do the agreements include appropriate and enforceable noncompetition covenants, nonsolicitation covenants, and nondisparagement covenants? If there are inadequacies in these documents they should be corrected before the sale process begins as these deficiencies could delay or even result in a break down in sale negotiations.

The prospective seller should next assess the importance of the key employees to the business and their degree of participation in the sale process. A determination will need to be made of which employees will be advised of the prospective sale and when. The chief financial officer almost always has to be advised of the sale very early on in the process since so much of the data that must be disclosed to a prospective buyer in due diligence will have to be assembled by, and flow through, the chief financial officer.

It is important that employees do not learn of the sale from third parties or too early in the process as they may become concerned with their future at the company and decide to seek alternative employment while they are still employed rather than after their employment has been terminated by the buyer. One means of minimizing this risk is to ensure that confidentiality agreements are in place with those employees who will be advised of the sale, as well as prospective purchasers and their advisors, prohibiting them from disclosing or discussing the fact that the company is for sale. Systems should be put in place to minimize the risk of disclosure through the use of virtual data rooms, password protection of documents, and the like.

Many prospective sellers enter into agreements with select key employees providing compensation to them if they remain with the company through the date of sale, and perhaps for a period of time thereafter. Payments under these arrangements, generally referred to as retention payments, incent employees to remain with the company and provide additional support for the confidentiality, noncompetition and other restrictive covenants referenced above.

There can be significant tax planning opportunities and hazards for the unwary in establishing these types of arrangements. Consideration needs to be given to their income taxability to the employee, their deductibility to the employer, the application of FICA and other payroll taxes thereto and the avoidance of the draconian IRC § 409A tax and the golden parachute penalty which is the subject of IRC § 280G. These dangers can generally be avoided but require expert analysis and advice.

A sale of a company can provide significant financial rewards and satisfaction to the owners of a business, but to maximize its benefits for all parties concerned appropriate consideration should be given to its effect upon employees. Expert advice from experienced counsel is critical to taking advantage of the opportunities and avoiding the risks described in this article.