Why employee options must lapse on an exit, or else risk the exit itself

by | 12 Jun 2018

We always include a clause in an employee option that says (in effect this):

shortly after an exit, the option will lapse in full.

Founders often complain that this conflicts with the intention of the employee options. The point of the option is to encourage the employee to stay. Surely losing this effect at the time of the exit is the worst thing possible?

This article will explain some uncomfortable realities of an exit, and why the clause is so important.

If a buyer wants to buy the whole company, nothing else will do

The whole is worth more than the sum of its parts. This applies particularly to companies, where the difference between 100% ownership and 99.999% ownership can be significant. This is because any buyer will have their own vision for the company: this will normally involve changing how the company is funded and managed, and often integrating the business with others or splitting it up. That tiny shareholder is a barrier to achieving that, so it’s important to have a clear strategy to buy out that tiny shareholder. The alternative is begging that shareholder to do it out of their own good will – a scenario that’s likely to result in that shareholder asking for their shares to be bought out for a high price.

A buyer will have its own intentions as to who to keep and how to motivate them

As a founder, you will have your own ideas as to who is key to the company and how to retain them. But an exit means an exit – your ideas will cease to matter once you’re no longer a shareholder.

The buyer will have its own ideas as to who to keep and how to motivate them. It will have its own set of advisors and probably existing employee share schemes which it may want key employees to join.

You need this clause

The removal of all shareholders is likely to be a condition of an exit. If there is no way to remove every last prior shareholder, there’s a good chance the exit will not go ahead.

This clause may be your only way of ensuring a successful exit.

Your instinct may be correct, but…

There are circumstances where it is very important that some employees are bound in following an exit. However, removing this clause merely weakens your negotiating position with an employee on an exit. There are likely to be other ways to bind an employee to the company following an exit, which a Granted specialist can discuss with you.