The importance of good leaver and bad leaver clauses

Good leaver or bad leaver shareholders - importance for growth businesses

If you have set up a high growth business, there is a good chance that as you grow, you will need to create (allot) more shares either as part of fundraising or incentivising key staff. A key consideration which is often overlooked is thinking about the circumstances in which those shareholders might exit the business and what should happen to their shares if they do leave.

This is why having good leaver and bad leaver provisions is a really important way of protecting your business and other shareholders. A very "black and white" approach may not always be best and some flexibility may also be important in determining and defining whether an exiting shareholder is penalised.

When to think about getting clauses in place

Triggers for implementing good or bad leaver rules typically include :-

• As soon as you set up business - there are good reasons to have leaver clauses in a shareholder agreement right from the time you set up your company

• When you recruit senior employees

• If your employees are being offered shares or share options

• If you are seeking new investors and investment

Leaver clauses can be included either in changes to your company articles, a shareholder agreement (or investor agreement)or other key documents such as some of your employment contracts and/or share scheme rules.

Thinking about the many different circumstances in which a shareholder may leave is important at an early stage of your business. We are experienced in advising on all aspects of leaver provisions and the underlying situations/transactions/concerns that give rise to consideration. We can draft up rules either for your articles, shareholder agreement, employee share schemes or other purposes. We are practical and cost effective. Please do get in contact.

Leaver clauses to force compulsory transfer of shares

Without specific provisions in your company articles of association, shareholder agreement or employment contract, you cannot compel a shareholder to transfer shares. They can retain shares even if they have acted directly against the company’s interests. For good leaver or bad leaver clauses to become operative, the company must have the specific right to force transfer of shares back to the company or other shareholders under set conditions.

The risk of compulsory transfer rules is that key employees or highly sought after potential recruits will be very nervous of such clauses because they can result in them not accruing the full or any benefit of shares.

Consequently, the terms of compulsory transfer rules as well as the triggers for leaving on less than good leaver terms should be carefully considered, perhaps allowing for a degree of flexibility and negotiation with different shareholders.

Advantages of compulsory transfer from the company’s perspective generally include :

• Preventing an employee waiting for valuable shares to vest and then jumping ship to a competitor and retaining the full benefit of shares.

• Shares which are transferred back to the company can be used to incentivise or reward other members of staff.

Good leavers

Defining what will constitute a good leaver is really up to each company. The obvious examples of what most companies will consider to be a good leaver will include where staff are made redundant or have to cease working because of ill health or death. Length of service may also be a factor.

The classification as a good leaver will often result in the shares being transferred at fair market value. How that is calculated should be clearly defined.

Bad leavers

As with good leavers, there are no set rules about how a company might designate a bad leaver. The most obvious examples of a bad leaver are where a shareholder has defrauded the company, is dismissed due to misconduct or poor performance, brings the company into disrepute, commits a criminal offence or is made bankrupt.

The consequences of being a bad leaver can vary considerably. The most common consequence is that the exiting shareholders shares are valued at less than fair market value, with a wide range of possibilities as to what the penalty might be.

Intermediate leavers

It is worth considering whether rather than designating a leaver as good or bad, there are many exiting shareholders who may not have been wholly loyal or top performing but who aren’t bad leavers. So, for example if an employee has shares under a share scheme which vested after 2 years, but they then leave 6 months later but do not go to work for a competitor, should they be classified fully as a bad leaver? Such an approach could feed through to recruitment difficulties.

It often makes sense for businesses to carefully consider not only what will amount a good or bad leaver but also somewhere in between, usually described as an “intermediate leaver”. This category is particularly relevant where a growth business has an employee share scheme  and wants to strike a fair balance and keep it’s reputation as being an attractive business to join.

Employee share scheme leavers

The most balanced approach to employee share scheme leavers is including reverse vesting. This is where any penalties for leaving are based on timescales and shares at risk of being penalised are generally not all the shares the employee has accrued. The longer the employee stays, typically after a minimum period, often a year, (if the employee leaves during that period he or she may be considered a bad leaver) with the company, the lower the amount of shares which are at risk of being transferred at less than market value.