Good leaver, bad leaver? What startups and employees need to know about leaver clauses

Here’s what employees, founders, and companies need to know about leaver provisions, including the traditional definitions of good and bad leavers, and how to use these clauses to motivate rather than punish.

When you’re granted share options in a company, thinking about what happens to that equity stake when you leave may not be top of your priority list. Fast forward a few years, though, and when you decide to move on, the leaver provision in your contract suddenly becomes very important. Are you treated as a good leaver, or a bad leaver?

Companies use leaver clauses to define what will happen to founders’ and employees’ equity when they leave the business. 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 standardization: every company has its own definition of what makes a good or a bad leaver.

Meanwhile, in a hyper-competitive market for talent, companies have an opportunity to demonstrate their values in how they define good and bad leavers. Are companies serious about making employees true owners, by rewarding their commitment with equity? Or should leaver clauses be focused on preventing dilution and preserving the equity value for existing shareholders?

Here’s what employees, founders, and companies need to know about leaver provisions, including the traditional definitions of good and bad leavers, and how to use these clauses to motivate rather than punish.

What makes someone a good or bad leaver?

Companies can define good and bad leavers however they choose, usually drawing on the advice of their lawyers. The most common cases that see employees defined as a good leaver, and hold on to their vested share options after they leave the business, are:

  • Retirement;
  • Serious illness or death (in which circumstance the employee’s share options would transfer to the next of kin);
  • Being made redundant through no fault of their own, e.g. as a result of a merger, or because the role is no longer necessary.

In contrast, bad leavers – who lose the right to retain any shares or share options after moving on – often include employees who:

  • Commit gross misconduct;
  • Are convicted of a crime, such as committing fraud or embezzlement;
  • Break a noncompete clause or violate the terms of a shareholders’ agreement;
  • Voluntarily resign, or before reaching a certain milestone, e.g. before all their shares have fully vested.

This last point is a source of contention. There are contrasting opinions on whether to designate employees voluntarily moving on as good or bad leavers. We’ll cover this debate in more detail later on. But first, let’s dig into why leaver clauses 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 fulfill 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.

The reason for this ‘friendlier’ treatment is because a demotivated founder sticking around just to hang on to equity presents an operational risk. A disengaged founder can have a dramatic effect on performance and productivity across teams, so boards may decide to give them the ability to move on while recognizing their contribution by allowing them to retain their shares.

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.

Where does accelerated vesting come in?

When certain people move on from a business (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, as well as an event like a sale or acquisition.

The case for relaxing employee leaver clauses

Deciding whether an employee should be treated as a good or bad leaver is sometimes pretty simple. For example, employees found to be exfiltrating data or engaging in workplace misconduct have actively harmed the company, so it makes sense that they shouldn’t be entitled to their equity.

However, in other ways the decision-making process can be surprisingly complex. Let’s take people who resign voluntarily. Should they be treated as good leavers, or bad leavers? Here, there is the potential for a misalignment between what the company thinks is responsible financial stewardship – trying to prevent ‘unecessary’ 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 favor 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 turnover, especially startups. 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 penalized. Does this kind of environment represent a best-in-class culture?

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 recognize 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 business?

Leaver provisions are a balancing act. You don’t want to give away so much equity to the early cohort that you can’t incentivize 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.

In summary: use leaver clauses to make equity fair for everyone

Bad leaver clauses are an essential part of a robust equity plan. But when they’re used punitively, they can damage culture and loosen the connection team members feel with the prospect of owning an equity stake in the business. When used appropriately, progressive leaver clauses can be a valuable tool for preserving employees’ motivation and engagement.

It’s important for employees, founders, and the company to have a clear understanding of what happens to people’s equity when they leave. However, treating leaver provisions as a deterrent ultimately hinders your ability to grow and potentially damages your reputation. Instead, use these provisions to reward employees for the years of work they’ve given you. This is the way to build a culture that takes ownership seriously.

Learn more about equity and share ownership on Ledgy's blog.

03 May 2022
Joe Brennan
Content Lead & Drone Theorist

"Equity ownership is not only important for aligning incentives between founders and investors, but crucially it drives alignment across the entire organization. CFOs, Heads of People and law firms love that Ledgy integrates with other HR systems and third parties involved in managing equity, creating a single point of truth. And Ledgy delights users with its ease of use."

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