What is a Retention Bonus and How Does it Work?

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When Should I use a Retention Bonus (Stay Bonus)?

From: Your Multimillion-Dollar Exit by Wayne Zell

Q: What is a retention bonus in the context of a business sale?

A: A retention bonus (sometimes called a Stay Bonus) is given to an employee for “staying” with a company for a certain amount of time after it has been sold. These bonuses are usually offered to key employees who play a critical role in the success of the business (examples include key management or senior engineer or customer relationship positions).

Q: Why are retention bonuses important in a business sale?

A: Retention bonuses protect the:

  • Seller of the business by keeping key employees incentivized to remain at the company and help the company achieve agreed upon targets after the sale of the company. Sellers may also have additional payouts that are “earned” and depend upon company results for some time after the sale during the “earnout period”.
  • Key employee by providing job security and incentives before, during, and after the sale of the company.
  • Buyer of the business by keeping the intellectual capital (key employee knowledge) with the company while the buyer learns the ins and outs of its new business.

Q: Who typically pays the retention bonus (stay bonus), the buyer or the seller?

A: Retention bonuses can be paid by the buyer, the seller, or sometimes shared between both parties.

Q: How much should a retention (stay) bonus be?

A: Retention bonuses (stay bonuses) vary widely from 25% to 90% of the employee’s base salary. They vary depending upon the company, industry and employee that is being asked to “stay” after the business changes hands to the new owner.

Q: What happens if the key employee leaves or is terminated during the retention bonus period?

A: If a key employee leaves voluntarily, dies, or becomes disabled during the retention bonus period, they will typically receive only the portion of the bonus they earned before leaving.

However, if the employee is terminated “without cause” or leaves with “good reason” (example: demotion), the entire bonus could be accelerated and paid in full to the employee.

Q: What is meant by terminated “with cause" regarding retention bonuses?

A: Terminated “with cause" usually refers to situations where an employee engages in misconduct or bad behavior that justifies their termination. In such cases, the employee may lose the entire retention bonus. Terminations with and without cause should be negotiated in the retention bonus agreement.

Q: When should you (the business owner) offer a retention bonus?

A: When retention bonuses are provided to key employees before a sales process starts, it is seen by employees as a gesture of appreciation for their loyalty and hard work. It helps key employees stay at the company while building up the company towards a future sale. It also helps employees remain invested in the company’s success while leading up to a sale, during the ultimate sale and after the sale.

When retention bonuses are offered during the sale process or near the closing of a sale, it can be seen as disingenuous to the key employees. It could also imply to the buyer that they should lower their purchase offer for the company because the employees are necessary for the company’s long-term success and without them the company won’t be as profitable.

Q: When does a retention bonus start & how long does a retention bonus last?

A: Retention bonuses don’t begin until the company is sold or changes hands. The period can range from 12 months to as long as 36 months after the sale closes. The payout of the bonus can occur incrementally over that time or as a lump sum at the end of the period.

Q: What should key employees consider when negotiating retention bonus agreements?

A: Key employees should ensure that the retention bonus agreement includes provisions that protect their interests, such as: full bonus payment in case of termination without cause or leaving with good reason.

In conclusion, retention bonuses are a valuable tool in ensuring that key employees stay employed, focused, and are committed to your company’s success after a business sale, especially when your earnouts are involved. The terms of these bonuses are critical and should be clearly defined in the retention bonus agreement to avoid misunderstandings or disputes.

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