Good Leaver/Bad Leaver Clauses and Provisions Explained

Every employee with shares or share options should have leaver provisions set out in their employment agreement or equity contract. But what makes a good leaver or a bad leaver, and what are the consequences of leaver provisions for companies?

What are leaver provisions?

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Leaver provisions are clauses that define what will happen to founders’ and employees’ equity when they leave the business. They are usually set out in people's employment contracts or share option agreements.

Companies use leaver provisions for a variety of reasons. They help businesses appropriately reward team members according to their contribution to the company's growth. They can also enable fair treatment of employees who are affected by personal circumstances. From a practical perspective, leaver provisions can also help CFOs exert greater control over the cap table.

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Good leavers generally keep hold of their vested share options after they leave; bad leavers lose their right to keep any equity, even the options that have vested. In cases like gross misconduct, the answer is usually pretty clear. But outside the most obvious cases, there is little standardisation. Let's dig into the different circumstances that define good and bad leavers.

What makes someone a good or bad leaver?

There is no concrete guidance in employment law on how to deal with leaver provisions: companies can define good and bad leavers however they choose, usually drawing on the advice of their lawyers.

So which are the most common cases that see employees defined as a good leaver, and which circumstances see people deemed bad leavers? We've laid it out for you:

Some decisions – like being fair towards people struggling with ill health – are simple. But some of these categories are more complex. In particular, whether or not people who voluntarily move on are treated as good leavers or bad leavers is a source of contention. We’ll cover this debate in more detail later on. But first, companies and team members alike need to understand why leaver provisions often apply differently to founders and employees.

Why are founders and employees treated differently?

Inevitably, there is a difference between a founder moving on from a business and another team member with less company-wide influence. This discrepancy affects the way good leaver and bad leaver clauses are designed.

Many companies apply more restrictive clauses for employees, treating them as bad leavers by default unless they fulfil one of the requirements we listed above classing them as a good leaver. In contrast, founders are usually considered good leavers unless they have engaged in criminal activity, contract breaches or gross misconduct.

Being lenient with departing founders is in the company’s best interest in the long run. The departure of a founder often has a significant impact on a company: but using equity to force a founder who has lost interest to stay can be even worse. Founders usually hold high positions, overseeing important decisions and large teams. If they’re demotivated—biding time until their shares vest—they can become a bottleneck, holding back innovation, and dragging down morale.

The vast majority of other team members, though, do not present as systemic a risk to the company’s prospects if they are disengaged. They also bear less overall responsibility for the company’s success than a co-founder. Therefore, boards are less likely to use their discretion to allow non-founders to retain their shares after they move on.

Another reason that companies make it easier for founders to keep their shares is that equity often makes up a more significant part of a founder’s compensation when compared to an employee’s. Whereas employees receive salaries, founders often pay themselves well below market rate for the first few years. Instead, they hold most of their net worth in equity.

If a company takes away all the shares a founder holds when they leave, you’re effectively taking away the only compensation they earned in those early years. In addition, by classifying most founders as good leavers, companies give them the opportunity to reap the benefits of the risk they took, even if they didn’t stick around until the sale of the company or IPO.

However, it’s a balancing act. Given that founders typically hold a significant proportion of a company’s shares, you need to make sure that you are treating future dilution – from future funding rounds, new hires, etc – into account.

Where does accelerated vesting come in?

When certain people move on from a company (most usually co-founders), single and double trigger acceleration can make a big difference to their equity.

In a single-trigger acceleration, one predetermined event – usually a liquidity event like a sale of the company – causes all the founder’s unvested shares to vest instantly, ‘accelerating’ the vesting.

A double-trigger acceleration requires two events to trigger the accelerated vesting. This can often take the form of a ‘good leaver’ event, such as their job no longer being necessary, in addition to an event like a sale or acquisition.

Single-trigger accelerations are quite rare and are almost always restricted to co-founders. Double-trigger accelerations may apply to employees too. Even if acceleration clauses don't exist in people's employment contracts or option agreements, when a liquidity event does take place the board directors may decide at its discretion to accelerate vesting for certain employees (depending on the circumstances of the exit).

Why voluntary resignations should be treated as good leavers

The decision-making process with leaver provisions can be surprisingly complex. Let’s take cases where there is a voluntary resignation. Should that person be treated as a good leaver, or a bad leaver? Here, there is the potential for a misalignment between what the company thinks is responsible financial stewardship – trying to prevent ‘unnecessary’ dilution of equity by only rewarding people who stay for the long haul – and an equity policy that actually damages team members’ morale and motivation.

Historically, companies have broadened bad leaver clauses to include voluntary resignations as a way to recoup leavers’ share options and prevent excessive dilution of existing employees’ and investors’ stakes. When employees are classified as bad leavers, their shares and options return to the employee share pool. This means that when the company wants to give shares to new hires, they avoid having to issue more shares—which would dilute the value of shares that have already been issued—or having to transfer shares belonging to founders and investors to employees.

Increasingly, however, this narrow approach to leaver provisions is coming under scrutiny. As equity schemes become more popular, employees are becoming more educated about which policies are non-standard and weighted in favour of the employer, not the employee. If you’re pitching a generous equity plan as an incentive for candidates, it doesn’t look good when they find out they can lose all their share options just because they move on to a new opportunity.

So how can companies make leaver clauses work for them – and for employees?

1. Factor leavers into your equity planning

When companies set up employee equity pools, they usually start by allocating a relatively small portion of the company to employees – say, between 5% and 10%. But as companies scale, the board and leadership team usually intend to gradually increase the pool of shares put aside for employees as they grow. We recommend a best practice of giving 10% of the company to employees in the very early stages (pre-Series A), with the aim to grow the employee pool to between 15% and 20% over the years as your company expands.

This structure lets you account for new senior hires coming on board, as well as refresher grants and promotion awards for existing team members. Ambitious companies who want to grow the size of the employee equity pool over time shouldn’t lose sleep worrying about the fractions of percentages being ‘lost’ to team members who voluntarily resign.

Instead of seeing leaver provisions as a way to make sure investors and founders get to cling on to equity, plan ahead so that you’re able to meet your commitments to existing and new employees as you scale.

2. Before setting restrictive leaver clauses, think about culture

Many companies fear people turnover, especially startups and scaleups. Losing key team members hurts. Plus, hiring is expensive and time-consuming. This combination can even put your growth goals at risk.

The fear of losing expertise and incurring hiring pain has led some companies to use leaver provisions as a way to suppress employee churn. But team members who are only sticking around for their equity aren’t necessarily pushing the company forward. Rather than contributing to building a great culture, they may simply be biding their time until they can leave without being penalised.

Broad bad leaver clauses actually reduce the power of equity as an incentive. It is an unfortunate reality that people will leave your company for a new job or opportunity at some point. In fact, watching people grow and develop is one of the joys about working in an early-stage company. It pays to recognise the contributions these team members have made.

It’s also worth remembering that if team members see any share options as being years down the line, it becomes more likely that equity is always seen as a pipe dream, rather than as a real, material incentive. Most companies already have vesting cliffs in place to ensure people contribute to the company’s development for at least 12 months before they acquire the right to share options. Is it right that leaver clauses act as a second obstacle for employees to hurdle before they own equity in the company?

Leaver provisions are a balancing act. You don’t want to give away so much equity to the early cohort that you can’t incentivise and reward the next generation of hires. But by letting people keep their vested share options when they leave, you’re rewarding the contributions they’ve made and building an inclusive, driven culture at the same time.

Use leaver clauses to make equity fair for everyone

Leaver provisions are an essential part of a robust equity plan. When used appropriately, they can be a valuable tool for preserving employees’ motivation and engagement. And, they enable CFOs and founders to control the cap table and potentially reserve more equity to distribute to other employees further down the line.

It’s important for employees, founders, and the company to have a clear understanding of what happens to people’s equity when they leave. Ledgy's best-in-class employee dashboards give team members unparalleled visibility into their share ownership, helping companies build equity into a cultural differentiator.

FAQs

What happens to a bad leaver's shares when they move on?

Bad leavers' shares return to the cap table, and are most often kept within the employee share scheme to distribute equity to new hires or existing shareholders who receive new grants (for instance, when they are promoted).