THE QUESTION
Three partners purchased a small company in unequal shares (65/25/10 per cent). Two partners are employees of the company, one for about 20 years. The purchase objective was to enhance efficiency and expand the company, and within three years sell it.
Because of his long tenure, one partner (25 per cent) may be able to secure a significant severance package from an eventual purchaser, perhaps as high as $300,000. (The other partners have no severance.) Any severance he receives will be subtracted from the purchase price, lowering the return for all the partners.
The company could legally put the partner on working notice and reduce his severance obligation to zero, thus driving up the potential purchase price.
What's ethical and fair in this situation?
THE FIRST ANSWER
Steve Winder, Partner at Borden Ladner Gervais LLP, Vancouver
The first consideration is the nature of the severance entitlement of the long-tenured partner.
If it is a contractual entitlement (in the form of a termination clause or change-of-control clause), the company needs to ascertain whether it provides for a guaranteed payout. If so, the company cannot satisfy this by way of working notice.
If it is a common law entitlement or the contract permits working notice, it is permissible to satisfy that obligation by way of working notice. The fact that doing so benefits the company, and in turn some of its owners, does not make it improper, provided there is no dishonesty.
There are some practical considerations. For the notice to be effective, an end date must be provided, which may be difficult given that the closing date is uncertain. And proceeding in this manner may sour the relationship and lead to the tenured partner leaving the company abruptly, which may harm the business and make a sale more difficult.
The best course may be either to accept this severance liability , or to negotiate openly to try to reduce it to an amount that is acceptable to all three.
THE SECOND ANSWER
Kyle Couch President , Spectrum Organizational Development, Toronto
The moment you switch from employee to owner, the game changes. 180 degrees. If the company performs, you reap the benefits; if it doesn't, you're out-of-pocket.
In this case, the ownership group's plan was crystal clear – buy it, fix it, sell it. The long-tenured employee should have shifted their personal financial view from paycheque to profit. It is likely that the person's tenure, and expertise, is the key reason for their addition to the ownership group. However, once they are an owner, their responsibility is to maximize the sale price, not hinder it.
Putting that person on working notice not only boosts the company's balance sheet by eliminating the large severance cost, it may also sweeten it by removing a salary. Assuming the company is well positioned for a sale, their potential payout may very likely exceed their severance.
Just as an underperforming product would be a potential deal breaker, so too is a sizable severance cost. The healthier the balance sheet, the greater the likelihood of a dream sale price.
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