Retention Bonuses in M&A Transactions
Retention bonuses are a financial incentive to keep employees with a company.
Retention bonuses are generally given during stressful times in corporate life events such as mergers, acquisitions, restructurings, bankruptcy proceedings, the completion of a large project or a critical production period. A retention bonus may also be offered when a company becomes aware that an important employee is considering leaving. In this period of labour shortages, we also see retention bonuses being awarded as an incentive to postpone retirement or as a disincentive to move to a competitor for a few additional dollars.
In the past, retention bonuses were mostly used by large companies and were typically offered to top-level executives to keep competitors from poaching them.
Some companies give the bonuses “in lieu” of raises because it avoids a permanent wage increase and is meant to “attach” the employee for a specific period.
The amount of a retention bonus depends on the reason behind the bonus, what the bonus is expected to achieve and the time to earn the bonus.
Employees can receive the bonus as either a single payment or in instalments over a period of time.
Use of Retention Bonuses in M&A Transactions
In M&A transactions, retention bonuses can be used by the seller, the buyer or both. The following illustrates how either the seller or the buyer can use this tool for their benefit.
Use of Retention Bonus by the Seller
Divestitures are very disturbing processes for employees as they create a lot of anxiety and uncertainty around their future employment conditions. Will I still have a job? Who is going to be my new boss? Will I have the same title and responsibilities? Will my work environment change?
The divestiture process will also add to certain key employees’ workload over and above their already busy daily tasks. Some sellers use retention bonuses, not only to keep the resources in place during the process and to deliver the business intact to the buyer, but as a form of participation in the upside of the transaction.
Use of Retention Bonus by the Buyer
For their part, buyers are known to implement signing bonuses to lock up current management after the deal has closed. Private Equity buyers are probably the most common users of retention schemes to lock up key performers. These can include offering phantom shares that only get vested after a set number of years or upon a liquidity event such as a sale or an IPO.
Disadvantages of Retention Bonuses
Retention bonuses are a common way to retain key people during specific times. However, they can have some disadvantages as they are a form of “paid servitude,” where you buy rather than earn employee loyalty. They can have unintended consequences that create damage.
- The key employee might keep the money and still leave: Depending on the retention bonus structure, even if the employee receives the payment over time, he or she might still leave after cashing-in even a smaller portion of the bonus.
- Offering the retention bonus may drive the employee to leave anyhow: Offering a retention bonus may appear to be an act of desperation by management as well as an alert that difficult times, or a large restructuring, are coming. As a result, it may unintentionally reduce the level of confidence that the employee has in his or her employer.
- The employee might use his or her “retention time” to search for new opportunities: the retention bonus may keep the employee around for some time but may trigger its search for other jobs. Also, nothing prevents competitors to offer signing bonuses to compensate for the loss of the retention bonus.
- Other “non-bonused” employees could ask themselves why they do not receive a bonus: retention bonuses are generally only given to important employees. This could create the perception of “two classes” with the disgruntled class creating a negative work atmosphere.
- The bonus will not increase the employee’s overall performance: since the retention bonus is an “agreement to keep the employee around” even if the employee’s performance is just maintained, the performance may not necessarily improve.
- The bonus amount offered may be incorrect: the amount offered may be too low and ineffectual, or worse, the employee may be offended. If the amount is too high, it might just be a waste of money.
Offering the bonus at the end of the contract period only and adding basic performance targets might help reduce some of the above risks. Another option could be to offer some stock options that vest over a period of time. These “golden handcuffs” might not be effective in keeping the employees for the short term or could be counterproductive if the value is not perceived to be tangible.
Key Questions Considerations:
Before implementing a retention bonus in the context of an M&A transaction, one should consider the following:
- Who will be entitled to participate?
- What should be the retention bonus amount be in percentage of base pay?
- When should it be announced and put in place?
- How long should employees stay before it gets fully vested?
- When should the bonus be paid?
- Should performance targets be added beside the passage of time?
- What are the tax implications for the employee and the employer?
- How should you account for the future cost in the yearly financial statement?
Although we are not HR specialists, Cafa has been involved in implementing several retention bonus schemes and other forms of long-term incentives for its clients. We would be pleased to share our “down-to-earth” experience with you on this and numerous other M&A subjects.
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