When it is time to raise money, it is time to have other people get involved in your business. Now although money/capital will give you the opportunity to expand your business, read your term sheets carefully. Good leaver/bad leaver terms are typically found in shareholder agreements, generally when you raise money. They can also be included in employee share schemes, investment agreements and/or the company’s articles of association. We explain what they are below so you can keep an eye out for them and understand the implications.
In short, their main purpose is to provide an incentive to shareholders who work within a company, including the founder, to work hard and receive a share of the growth. When someone decides to leave/cash-in this is generally known as a good leaver. There are also terms to deter a shareholder who is important to the business from leaving before an agreed upon date. These are bad leaver provisions, and can also be exercised if the employee is found guilty of some misconduct which might damage the business.
The focus of this post is about shareholder agreements. Within a shareholder agreement, the definition of a good leaver is generally an employee and shareholder of a company who:
The first 3 examples are the result of an involuntary event that brings an end to their contract of employment and triggers a good leaver event. Sometimes, however, there are provisions made for the directors to exercise their discretion to declare a leaver to be good which provides a little flexibility.
It would make sense then that a bad leaver is the opposite of a good leaver. It is often the case, therefore, that any other event of departure from the company is a bad leaver event. This makes sure all events are covered by the 2 definitions. A bad leaver is, therefore, an employee that:
These can be over complicated and often are because the company’s directors are trying to protect the company’s equity. With that said, whatever is agreed upon, it is very important that the drafting is clear and unambiguous. If you are unsure then hire an independent lawyer to have a look at your terms as this could avoid any disputes down the line.
Good leaver/bad leaver provisions are important because they can impact your “exit price”. As you can expect, it is often the case that a bad leaver receives less for their shares than a good leaver. The price is therefore heavily weighted in favor of a good leaver and heavily discounted for a bad leaver.
It is important to keep in mind that although they may seem unfair, well-drafted good leaver/bad leaver provisions are enforceable by law. Don’t assume they will not be exercised, even if you get along well with management. It is the board’s obligation to put the interests of the company first and if this means invoking bad leaver provisions, they are required to vote that way.
There are important differences between a contract of employment and a shareholders agreement. If you are a founder you should have both of these in place. If you do not, then you should do that sooner rather than later. A shareholders’ agreement is a contract made between shareholders. A contract of employment is made between an employee and their employer. The two are mutually exclusive, even if signed by the same person. What this means is that an employee has no right of recourse against their employer if they are in dispute with their co-shareholders. Similarly, a shareholder has no right of recourse with his co-shareholders if he is in dispute with his employer.
Keep in mind, however, that although mutually exclusive, well-drafted shareholders’ agreements will also require well-drafted contracts of employment. If this is not the case there can be legal complications. This relates to good/bad leaver provisions as a shareholders agreement will normally trigger a bad leaver event at which time the shareholder (who is also an employee) is now no longer an employee of the company. The main reason for this is that the shareholders all set out to ensure that they are all pulling their weight in order to share in their collective efforts. If, however, a shareholder is in breach of his contract of employment, why should they continue to take any benefit from the increase in value the other shareholders are contributing?
We always recommend taking professional advice. It may seem like an unneeded cost, but shareholder agreements are quite complicated and need to be examined by an expert. In just one hour, they will be able to spot things that are unfair to you and you may be able to negotiate.