Keeping it simple with employee share schemes, part 2: termination of employment

by | 4 Jan 2018 | employment

Worry about what happens to an employee’s options or shares when they leave can often lead to unnecessary complexity.

This is the second in a series of posts looking at some of the common barriers to a simple employee share scheme.

Why is it hard to keep it simple?

The biggest hurdle to keeping it simple is often the very valid concerns of founders. The aim of these posts is to explain that, although the concerns may be valid, they can usually be addressed without adding complexity.

What happens to an employee’s shares or options when their employment ends?

Nothing, unless there is an agreement with the employee that says something should happen to their shares or options.

If there isn’t any agreement, ex-employees become over represented among your shareholders. In the extreme, this can cause problems in having sufficient equity to reward current employees and can interfere with fundraising or even selling the company.

Is it typical for an agreement to be in place to deal with this?

Yes. The agreement is normally part of the option agreement or contained in the company’s articles of association, and is referred to as the ‘leaver provisions’.

Why are leaver provisions complicated?

They don’t have to be – but they often are as a result of trying to lay down in detail what happens in the future.

For example, leaver provisions typically divide leavers into two or more categories: ‘good leavers’, ‘bad leavers’ and sometimes ‘intermediate leavers’. Their reason for leaving (e.g. ill health, redundancy or resignation) determines which category they fall under. Each category is then treated differently in terms of:

  • The number of shares or options they can keep (if any)
  • How long they can keep them for
  • Whether the shares or options continue to subject to performance conditions
  • If some shares are sold, what price they can be sold for.

What’s the problem with complicated leaver provisions?

Complicated leaver provisions make the arrangement more difficult for an employee to understand. That causes an employee to value their award less, and reduce the positive effect on motivation.

In my experience, this isn’t balanced out by the greater certainty of complicated provisions, at least for early stage companies.

What looked fair for a leaver at the outset may not look fair six months down the line. Consequently, however detailed the leaver provisions, they often end up being overruled according to what ‘looks fair’ at the time.

What’s the solution?

Be harsh, but reserve the right to be kind.

That means if anyone leaves for any reason, they lose all their shares and options, but the board can choose to allow some or all shares or option to be kept.

Is that solution right for all companies?

No. This tends to work best for early stage companies focussed on an exit in 3-5 years.

So how can I work out what’s right for my company?

Get data. Get to know your employees. Get feedback. Ask the questions you’re afraid to hear the answers to.

If you give an employee an option that requires them to stay until the business is sold, and there isn’t an improvement in their motivation, it’s valuable to find out why. There are many possible reasons (e.g. how well you have communicated strategy, how strongly the employee believes in the business or their future with the business) and not all of those reasons require a change to your employee share scheme.

In short, start simple, and only change to something more complicated when you know it’s necessary.