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6 March 20184 minute read

'Good Leaver / Bad Leaver' provisions: A guide for businesses

Understanding 'Good Leaver' and 'Bad Leaver' provisions in private businesses

Today's private businesses, especially in New Zealand's tech sector, are involved in an intense competition for top-notch executives. Equity offers have become a common strategy to attract and retain this talent. However, a crucial aspect that demands careful attention is the crafting of 'good leaver / bad leaver' provisions in these equity offers.

Implications of 'Good Leaver' and 'Bad Leaver' Provisions

'Good leaver' provisions encourage executives to remain with the company, and 'bad leaver' provisions are geared towards discouraging their departure or protecting shareholder value from underperformers. Crafting these provisions requires a keen eye for potential future scenarios and possible outcomes.

The Compulsory Transfer Principle

A frequent clause in these agreements stipulates that an employee shareholder (Leaver) must sell their shares to the company or other shareholders upon departure. The details of this agreement vary; sometimes, the company or shareholders have the option to acquire the shares, while other times they are obligated to do so. This can create a complex dynamic that requires careful negotiation.

Benefits of Compulsory Transfer

  • It encourages executives to stay with the company until shares are fully vested or until a liquidity event.
  • It allows immediate availability of Leaver's shares for a replacement executive, avoiding share dilution.
  • It prevents the demotivating situation of growing equity for a former colleague potentially now at a competitor.

In unique cases, a strong executive might negotiate to retain some or all of their shares depending on their departure timing and providing they aren't a 'Bad Leaver'. Different variations can be applied in this context, further highlighting the nuanced nature of these agreements.

Deciding on the Share Selling Price

If a compulsory transfer is agreed upon, the next consideration is the selling price of the Leaver's shares. Commonly, this is determined by the circumstances surrounding the exit. If the Leaver is a 'Good Leaver', they are required to sell at 'fair value'. If they are a 'Bad Leaver', the selling price might be lower, or in extreme cases, nominal. However, the enforceability of these discounted prices can be questioned, as they may be considered unenforceable penalties.

Defining a Good Leaver and a Bad Leaver

One of the challenges is defining the categories of Good Leaver and Bad Leaver at the outset. The specifics of each departure can vary, so it's not uncommon for the company's board to have the discretion to classify a Leaver as a 'Good Leaver'. In venture capital scenarios, the investor(s) often have this discretion.

Leaving scenario Type of leaver (for the purposes of clauses relating to the retention and disposal of shares)
Death Good
Permanent disability or permanent incapacity through ill health Good
Permanent disability or permanent incapacity through ill health of the executive's spouse or child Good
Retirement (at normal retirement age) Good
Redundancy Good
Unjustifiable dismissal by the company Good
Dismissal by the company where the executive has failed to meet certain performance expectations (eg. KPIs)

Generally the most difficult category and will depend on negotiations:

  • sometimes good, where a failure to hit performance targets is not solely within the executive's control and it may seem unfair to penalise the executive in such circumstances
  • sometimes bad, if meeting performance expectations is considered critical (and the executive will have a high degree of influence on meeting performance targets)
Voluntary resignation by the executive

Will depend on negotiations:

  • often bad, particularly if the executive is critical to the future success of the company and/or is not readily replaceable
  • but can be good, if the resignation comes after a certain period of time (with an acceptance that executives who have provided a reasonable period of service will have contributed to an increased equity value and shouldn't then be penalised for moving on, especially if it is due to personal or family reasons)
Justifiable dismissal by the company for cause (including fraud or dishonesty) Bad
Departure within an initial minimum period (say 12 months) for any reason whatsoever Bad
Bankruptcy (although this will not always be a separate leaving scenario) Bad

The Importance of Time at the Outset

Despite being a time-consuming process, defining an appropriate set of Good Leaver / Bad Leaver rules is an essential investment for the long-term success of the business structure. With a fair and reasonable set of rules in place, the company can confidently move forward, knowing its key employees are aligned and incentivised.

DLA Piper has a wealth of experience advising both executives and companies regarding such arrangements. For further information or detailed discussions, feel free to contact our lawyers.