As anybody who has run a sizable business can attest, one of the largest headaches is hiring talented people, training them and keeping them. We have found that compensating employees of our portfolio companies with equity to be a beneficial practice on keeping talented employees longer and having them be fairly compensated for their work.
When employees feel as though they reap the rewards of their hard work and dedication, most often they will be motivated to do the job properly, on time and on budget. When employees are compensated solely on a salary or hourly basis, there is a disconnect between what is good for the company and what is good for the employees. For those who are interested in reading up further on the concept of incentives, I recommend reading “Drive” by Daniel Pink.
The question then, is if compensating employees with profit sharing or equity is better for the employees AND the company at the end of the day. Why do more investment companies not do it. This question may have various answers depending on who you ask. The answer that seems to make the most sense is that investment companies want to own all of the business equity themselves to make it easy to then sell 100% of the company later on. It is far harder to sell a company that the employees own a piece of than it is to sell 100% of the equity in a company that has salaried employees.
In addition to making the business harder to sell, compensating the employees with equity means a lower return for the investment company when the company grows. Because the investors mandate is to make as much money as possible for their investors, granting equity to employees is off the table.
Minerva works a bit differently. Our goal is to hold the company indefinitely and to make the transfer of ownership beneficial for everyone involved. Sellers receive fair market value (or above) for their business, employees maintain their salary and get additional compensation by obtaining an equity stake in the business and Minerva owns the majority of the business. You can read more about mid-market acquisitions and how Minerva works by reading our overview of selling a small-mid sized business post.
How is the seller compensated?
The business seller is paid at least fair market value for their business. If they are looking for the highest cash payment at close, we’re not a suitable option. If the seller is looking for a deal that gives them the highest compensation over the course of a few years and is most optimal for their employees, then I believe Minerva will be a very competitive option.
In most of our acquisitions, the seller is compensated in 4 parts. A down payment at close, a note payed over a couple of years, a royalty while they continue to operate the business and equity in the company. We combine all of these pieces in a way to give the seller fair market value for their business, grant the business employees equity to incentivise them and still have a large enough equity stake for ourselves to make the transaction worthwhile.
If you examine our business model and compare it to the standard leverage buyout model that has been the norm for decades, we think that you’ll agree that our option is far more compelling.
How are we able to do this?
Because we have proven expertise in acquiring businesses and great credit, we are able to get very favorable financing terms from certain banks and lending institutions. This leverage allows us to finance a down payment with favorable terms. Because we are not out of pocket the entire cost of the transaction, we can afford to be generous on the terms we offer sellers and employees. The remaining portions of the compensation that are paid to the seller are financed by the business operations.
Why take equity as part of the compensation package?
The lower mid-market is a very illiquid marketplace. There are hundreds of reputable businesses that don’t have offers. In fact, if it weren’t for SBA loans, We believe that almost no lower mid-market businesses would receive cash offers. Many sellers of lower mid-market businesses find that they may have their business listed on the market for years with no suitable cash offers. At the end of the day, it is difficult to find someone who is willing
to spend millions of dollars to buy themselves a job.
Receiving equity as compensation for your business may actually be a better alternative for many sellers. Our typical business seller retains ~20% equity in the business that they are selling and is compensated at fair market value for the other 80%. By retaining this equity, the sellers interests are aligned with our own, which is important to us. They will then be able to receive compensation on an ongoing basis, the same way we do.
In addition, we only invest in businesses that we feel comfortable managing and believe that we can grow. We have the resources and know how to grow our investments. Because the seller is an equity holder, they are able to benefit from this business management and growth.