If directors or employees leave, what should happen to their shares or share options?
It may be appropriate for the leaver to keep them, if for example, a founding director retires from a small family business. However, particularly if there has been external investment, this will not make commercial sense since that may make a startup uninvestable in the future.
A well advised startup will ensure that a leaver’s shares and share options can be bought back by the company or the remaining shareholders. In many cases, recognising that sufficient cashflow may not be available to either the company or the remaining shareholders to buy the leaver’s shares or share options, the company also has the power to sell them to outside investors.
The company will not want to reward people who leave on bad terms though, and will want to distinguish between ‘good leavers’ and ‘bad leavers’. In some cases, there will be an intermediate category of ‘grey leavers’. These provisions are also designed to encourage and incentivise directors and employees to depart from the company on good terms in the knowledge that they will be properly remunerated for their shares and share options if they leave.
A good leaver’s shares or share options will typically be bought back at their then fair market value. These shares and share options being bought back could include the good leaver’s future entitlements – a concept known as ‘vesting’.
Good leavers are usually those departing from the company on good terms following:
mental or physical incapacity impairing their ability to work
change in the remuneration, duties or roles as an employee.
The company may have discretion to determine that a leaver is a ‘good leaver’, in circumstances not captured above.
A bad leaver’s shares or share options will typically be bought back at the original issue price or, if lower, the then fair market value. The purchase price could also simply be the nominal value.
Bad leavers may be defined as anyone who is not within the limited category of good leavers. Sometimes, bad leavers are defined specifically as those who:
breach their contract of employment,
are dismissed for gross misconduct
leave within a certain defined period.
Founders are sometimes specifically excluded from being bad leavers and, if so, get fair market value for their shares or options.
There may also be a ‘grey’ leaver, who is likely be an individual leaving in certain defined set of circumstances.
Typically, grey leavers’ shares or share options will be bought back at a price between that paid to good leavers and bad leavers. This, for example, could be their then fair market value, but excluding unvested shares or share options (ie not their future entitlements to shares or share options).
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