One challenge almost every company faces is how to retain their employees and keep them motivated. One method used (frequently in the startup world) is by offering equity in the company to employees as part of their employment package - normally an Employee Share Option Plan or an Employee Share Plan. An Employee Share Plan usually gives employees straight-up shares, while an Employe Share Option Plan grants the employees options to purchase shares - both are normally subject to certain conditions such as continuing employment with the company, performance hurdles or vesting over a period of time.

This system rewards those who work hard and stay loyal to the company with carrots, and deters noncompliant or underperforming employees by (figuratively, hopefully?) hitting them with sticks. Part of this system is to include ‘Good Leaver provisions’ and ‘Bad Leaver provisions’ in documents such as shareholder agreements, Employee Share or Option Plans and sometimes company constitutions. These provisions set out what happens when an employee ends their employment relationship with the company. You would expect these conditions to be the same across an employee’s employment agreement, the Employee Share or Option Plan and any shareholder agreement.

Good Leaver Provisions

A ‘Good Leaver’ is generally defined as an employee who ends their employment contract on neutral ground / by agreement with the company or due to involuntary circumstance such as:

  • death;
  • incapacitation through physical or mental illness;
  • enforced redundancy;
  • unjustifiable dismissal by the company;
  • dismissal by the company due to failure to meet performance targets or expectations (where failure is not entirely within the Leaver’s control and it would be considered unfair to penalise the Leaver in such circumstances); or
  • voluntary retirement after a pre-agreed period of time.

Bad Leaver Provisions

A ‘Bad Leaver’ on the other hand could be defined as an employee who leaves their role:

  • in order to pursue employment elsewhere before expiry of a pre-agreed period of time;
  • as a result of voluntary resignation;
  • due to justifiable dismissal by the company, including fraud, dishonesty or misconduct;
  • bankruptcy; or
  • dismissal by the company due to failure to meet performance targets or expectations.

Admittedly, there can be a pretty big ‘grey’ area in the middle between a ‘bad’ leaver and a ‘good’ leaver, which is where a lot of disputes can occur. For example, a failure to meet performance targets might not always be within the control of the employee. Long story short, it’s always a good idea to get a lawyer to carefully draft these provisions across a variety of documents to check they make sense and you cover as many bases as possible.

Bye Felicia

Apart from receiving a farewell card and a bunch of flowers (or a lowkey escort out of the building by security…), what happens when the Goodie or Baddie leaves?

It is common that an employee shareholder is obliged to sell their shares when they leave the company. In some cases, the company will have the option to acquire the leaver's shares, while in other cases the company will be required to buy back the leaver's shares. Compulsory transfer of shares is a smart clause to include as it serves many benefits back to the company, including:

  • incentive for executives to remain with the company until their shares are fully vested (read more on vesting here);
  • the Leaver’s shares are available immediately for a replacement executive, without the need to issue new shares and dilute other shareholders; and
  • the remaining management team is not left in the potentially demotivating situation of working to grow the equity position of a former colleague (who may end up at a competitor).

Either way, Good and Bad Leaver provisions are important as they regulate the ‘exit price’ for an employee leaving the company - i.e. the price they will get paid for their shares. As you might expect, normally the Bad Leaver will receive less for their shares (normally a 25-100% discount on the fair market value of their shares) than the Good Leaver (usually receives fair market value of their shares).

The Good and Bad Leaver provisions can be really important, especially for the founders of a start up company that can become subject to these provisions if they accept any kind of seed or VC funding.

The board of a company will generally have a fair bit of discretion to bend the rules around these provisions given the potential difficulty surrounding these concepts - such as defining what kind of leaver an employee is, and the calculation of an exit price. Allowing the board discretion also ensures the company flexibility to preserve the company’s shares and value at all times. Regardless, it is super important to spend sufficient time considering, negotiating and clearly documenting your stance on employee leavers that are also shareholders to avoid nasty disputes over mismanaged expectations.

Have you had experiences with good or bad leaver provisions? What kind of things do you think might be problematic or tricky events to manage? Comment below.