When valuing a closely held business, I frequently pose the following question to the business owner: what do you think the business is worth without you? When a business is sold, the selling owner does not go along with the deal. The seller might agree to work for the new owners for a limited period of time, but the buyer must be confident that the business can stand alone and continue to generate cash flow without the seller. Even if you don’t plan on selling your business to an outsider, its value will partly depend on how strong the business structure and management is. If you are key to the business’ success and can’t be easily replaced, you are “key” to the business but you also represent a large risk that will tend to drive down the value of the business.
A similar question can be asked in regard to key employees: what is the business worth without your key employees? If they are critical to the success of the business, their possible departure represents a risk to the business. In either case—if the business is overly dependent on the owner or on a key employee, the prudent owner will try to reduce this risk (and increase business value) by a strategy to develop and retain key employees who have incentives aligned with those of the business owner.
We begin our discussion with the case of a business dependent on a key employee.
There are legal steps that you can take to protect the business from the departure of such an employee—you can have the employee sign a non-compete agreement. This might prevent the employee from leaving and competing with you in your geographic area for a limited period of time (maybe 2 years—ask your lawyer!). However, key employees can always leave and take a job or start their own business out of your area. To be more effective establish a key employee incentive bonus plan that will encourage your key employee to remain with your company and increase your profits!
Successful key employee bonus plans tend to share certain characteristics:
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