What are technology investors doing to retain and incentivise key personnel in their acquisitions?
12 January 2022
With many technology companies using transactions to acquire talented people, as well as products and services, it is no surprise that employment issues are at the top of their due diligence agendas.
These companies are bringing a different perspective to the personnel element of acquisitions and collaborations than has traditionally been the case in other industries.
Since “acqui-hiring” is so often a main motivation for doing deals, they take a far more collaborative approach, seeing employees, at all levels from founders down, as a valuable part of the transaction.
Retention incentives growing
In many jurisdictions, we are seeing acquirers placing greater emphasis on retaining employees via incentive arrangements.
Many technology companies are specifically targeting companies that can help them overcome skills shortages in key roles, not least software developers and engineers, and to bring in new synergies and innovative minds.
Restrictive covenants are an important tool in protecting an acquirer’s interests but generally only provide protection for a year post termination and are often hard to enforce in practice in some jurisdictions.
To enable staff to share the fruits of the success of the business, so that everyone has a common goal, the use of incentive arrangements such as restricted share plans and share option plans – which vest over a multi-year period – are seen as a valuable incentive and retention tool.
Earn-out arrangements are also not only becoming more prevalent in many jurisdictions, but tend to be of higher value and vest over longer periods than before, even though they do have the potential to create conflict where there are disagreements over company valuations at key trigger points.
In jurisdictions where there are strict foreign exchange controls, the legal regimes may not cater for certain incentive arrangements.
For example, employers do not have the ability to offer equity-based incentives of overseas, unlisted companies to their staff in China.
This may create a situation where the members of top management across a global workforce are incentivised in different ways. An incentive arrangement structured in the form of a simple cash bonus in places with high tax rates (the individual income tax in China and the UK is up to 45%) can often be seen as less attractive.
Not all incentive and retention arrangements are measured by reference to financial performance.
Increasingly, we are seeing buyers focus on non-financial metrics, such as diversity, equity, and inclusion goals, to get clearer assurance that the target is taking proper regard of governance and ESG issues.
A key governance issue is succession planning.
Buyers will often be looking for evidence that the target has properly thought through who will lead the company in the future and what obligations and objectives are in place for the leadership team over the next few years.
While this focus makes good business sense, it can sometimes be challenging to document from a legal perspective.
Employees central to due diligence
Given the importance and value attached to people in many technology deals, due diligence procedures often seek to establish important aspects of the target’s culture, such as staff morale or the relationship with the employee representatives. Such issues are often little more than a box-ticking exercise for other sectors.
Buyers will, for example, often send HR or employee relations specialists in to “take the temperature” and scrutinise staff attitude surveys. Staff turnover/retention rates will also be closely analysed.
But technology companies face some fairly unique challenges, not least that they are often the biggest employers of younger, often more transient workers, who play a large role in the so-called “gig economy”.
The use of contract workers and consultants, often based in different jurisdictions, and working at all levels in the company alongside full-time employees, is now commonplace in this sector. For that reason, risks around the classification of employment status will form an important part of the diligence process.
This remains a contentious area of the law even though there have been some important judgments in key jurisdictions, including rulings by the UK’s Supreme Court in respect of Uber and the taxi and delivery business, Addison Lee.
This is an area of the law that has yet to catch up with the more fluid employment practices that are prevalent in the digital age. Ultimately, it may require changes in public policy to bring employment laws into line with this changed economic reality.
IP and confidentiality
Transactions in this sector are not, of course, only about people and employment practices. Protection of IP remains a critical issue for both companies and employees, and measures around securing trade secrets are often a huge priority for both parties.
IP protection takes on different guises in different jurisdictions.
In the UK it remains relatively straightforward, with the principal focus being on ensuring that employment contracts provide sufficient protection for trade secrets.
China takes a similar approach although, typically, companies involved in R&D have a growing awareness that employees should be rewarded, in addition to their salaries, for their efforts in creating important inventions. If the reward structure is not agreed upfront, there are financial implications for the business and the matter can become contentious.
Overall, the emphasis that technology companies place on the value of employees is a positive trend rather than a hindrance to deals.
Companies in other sectors should take note of this approach.