Conditional Equity Program (CEP)

  By Michael Neidle  |    Wednesday November 10, 2021

Category: Uncategorized



Very often an owner of a company would rather sell his company to his key employee(s) via a CEP and reward those who helped build the company and reward them by essentially inheriting the business at the fair market price. This, rather to go through the rigors of a potential sale via an outside party, go through all the rigors of a dealing with brokers, having to go through due diligence, the potential exposure of being “on the market”, possible staff turnover due to their uncertainty of employment on a transition, a slew of hassles and wasted time, etc.  The CEP route provides the recipients with an opportunity to buy the company and continue to grow it, for a win-win scenario. This is like a Management Buyout (MBO). The difference is that certain milestones during the transition process need to be met and no equity is earned until the sale is completed. And if the CEP falls apart and an outside sale is always a fallback option.

The market value of the company at the time of sale to the CEP should be established by a well-qualified industry appraiser. The targeted price for the company is typically set on the culmination of a 3-to-5-year growth period. Prior to sales the CEP equity is zero (0) and may not be traded, bartered, or transferred to any other party. The purchase price of the company needed by the CEP is set at the end of this growth period. The bulk of the financing needed to pay for the sale would then typically come from the free cash flow generated during the growth period. This owner sets by this value and how long the CEP has to pay it off, but the current owner may provide some forbearance if need.

The CEP must be continually employed with the company and will be forfeited in its entirety on termination of employment, be that voluntary or involuntarily. There shall be no proration based on service time with employee, who must also maintain accurate and timely records and KPI’s. The CEP should provide for a smooth transition of the sale of the company as know it well. It will be the job of the CEP to reach the sales, profits, and market value goals in the agreed upon time horizon. The purchase price of the company may be discounted by the current owner, this may vary from 0 to 20% on the market value and the end of the growth period. As an example, if this market value were to be $10 million, and a 10% were provided to the CEP, this would worth be $1 million, and $9 million would be due to the exiting owner. The CEP value would normally be applied to the final year’s payment. If the CEP then continues to grow the profits of the business, they should more than make up for the purchase price to the exiting owner. As part of this process, periodic financial and KPI targets will be tracked to help the CEP achieve the selling price. If the financial conditions are not met the transaction would not be consummated and the sale would not occur. 

 

This is like a mortgage with a bank, where the bank owns the house until the last payment has been made. Here the exiting owner continues to own the company until the price is paid in full. If that were to happen without forbearance, the company can be sold to an outside party.


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