We all know that leaver provisions are usually the most controversial, and certainly emotive, point of negotiation in an investment deal.
On the one hand, investors need to know that founders or other management shareholders (who I’ll refer to collectively as the “founders”) are committed to the business. After all, the decision to invest is rarely based on technology alone, but rather, an investor’s belief in that particular management team to deliver. If things don’t work out, leaver provisions offer a means to ensure that an ex founder (who is potentially aggrieved by his or her departure) won’t be a powerful, but troublesome shareholder. It would also feel pretty unfair to other shareholders if an ex founder, who left the business some years before an exit, stands to be a major beneficiary, when they’ve done none of the hard yards to bring it about.
But, most founders seeking investment are not intending to leave the business they’ve worked so hard to get to this point. They are, however, understandably concerned that they could be pushed out of their company and lose the value in their shareholding, particularly when investors can appoint directors to the board. Ultimately, if leaver provisions are too draconian, founders will feel disincentivised, which is no good for anyone concerned. Striking the right balance on leaver provisions as between founders and investors is a delicate matter.
Many people (myself included) will tell you that leaver provisions are just part of the deal. That’s absolutely true. Founders shouldn’t expect to raise any significant investment without being asked to sign up to leaver provisions. It is a standard investor term and you’ll likely find it in the term sheet – “The Company’s Articles will contain customary good and bad leaver provisions”.
But, what different investors regard as “customary” can vary significantly.
So, the real question about good and leaver provisions isn’t whether founders need to sign up to them, but rather, is what is being proposed fair and in line with market norms?
In truth, there is a wide spectrum of what might be classed as “market” when it comes to good and bad leaver provisions. Lawyers acting for investors will draft these in their preferred format meaning that (in the absence of specific details having been agreed at term sheet stage) they are likely to be investor friendly. But, more often than not, they will be negotiated on a case by case basis and you should keep in mind the following:
Look at how these terms are defined. At the very least, you’d expect to see a good leaver defined as a person who leaves the company as a result, of death, ill health or redundancy. A bad leaver should always include a person who leaves the company as a result of summary dismissal, gross misconduct, breach of IP or confidentiality, or a person who leaves in breach of restrictive covenants. What lies in between can be a grey area.
Investors usually prefer to set out specific criteria which constitutes “good leaver”. Anyone who does not meet the criteria is, by default, a bad leaver. If that’s the case, consider whether the good leaver definition can be expanded to include other scenarios e.g. unfair dismissal, leaving the company after a specified period of time (3-5 years is typical, or any other period linked to objectives set out in the business plan). Alternatively, could the definitions can be flipped whereby the criteria for bad leaver is specifically detailed and everyone else is automatically good leaver?
It is highly likely leavers will be obliged to offer their shares up for sale. Whether you are a good or a bad leaver will determine the sale price e.g. bad leavers may need to offer shares for sale at nominal value, or the price at which they acquired the shares (or fair value, if that’s lower). In either scenario, it may mean being paid very little for their entire shareholding. If a purchaser cannot be found, their shares may convert to a class of deferred shares, with little economic value and no voting or pre-emption rights.
Good leavers will usually be entitled to fair value (but do check how fair value is arrived at and the factors to be taken into account when making a determination).
It may be possible to negotiate concessions for good leavers which enable them to retain some of their shares subject to achievement of specific milestones, including length of service (this may operate on a sliding scale whereby the percentage of retained shares will increase for longer service). Any retained shares will likely be subject to conditions such as loss of voting and/or pre-emption rights.
Similarly, US investors tend to favour reverse vesting arrangements whereby good leavers can vest a percentage of their shares for each year of service.
How a founder has come to obtain their shareholding will be a relevant factor. It is generally accepted that any shares purchased as part of an investment round where the founder has paid the same price as a third party investor should be carved out of leaver provisions, save in the case of gross misconduct.
It is entirely normal to find that you could still be subject to leaver provisions after leaving a company. If you were a good leaver but subsequently do something which makes you a bad leaver, your good leaver treatment could be reversed.
A few practical points to remember:
Ultimately leaver provisions will depend on a number of different factors which need to be considered on a case by case basis. Some investors will take a stricter approach. Some circumstances will merit more concessions. Different jurisdictions have different “norms” and what is market will change over time. Comparisons with other companies at a similar stage are not always helpful, but good lawyers working in the entrepreneurial space will be able to advise you appropriately. If you have any questions or concerns about leaver provisions or need some help to negotiate them as part of your investment deal, please don’t hesitate to get in touch.