The authors, Kolja Czudnochowski and Christopher Hahn, deal with the entrepreneurial, corporate law and tax law opportunities and challenges of employee participation. Together they also founded a company that supports startups and SMEs in their implementation. On Gründerszene they regularly explain various aspects of ESOPs and VSOPs.
Today: What happens to shares when employees leave the company, what good and bad leaver regulations are all about, when cases can even end up in court and what sensible compromises there are.
Leaver and vesting regulations are essential components of employee participation programs. By meaningfully linking these two regulations, it can be ensured that the shares of beneficiaries are really linked to their actual contribution to the company’s success.
Vesting is a principle that ensures that employee participation increases in value over time. It’s about rewarding those employees who are not just with the company for a short time, but with perseverance and commitment contribute to the growth of the company. This not only promotes team spirit, but also loyalty to the company.
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If an employee leaves the company or the employment relationship with the company changes for another reason during a certain minimum period of time (the so-called vesting period), this is the case he loses the virtual or real shares granted. This regulation is not unfair, because shareholdings merely serve as an incentive that the employer grants in addition to the salary in order to bind the employee to the company in the long term and motivate them to consistently perform at a high level. If that doesn’t happen, the incentive may also be lost.
Bad und Good Leaver
Leaver clauses and the individual cases in which the beneficiaries lose all or part of their shares must be defined precisely and transparently in the respective contracts. In cases of doubt, inaccuracies will be to the detriment of the company.
If Bad Leaver refers to the cases in which the beneficiary loses all of his shares. This is usually the case if the employee’s employment relationship is terminated for good cause – that is, the employee is significantly to blame for the termination of the employment relationship. Other classic cases include the opening of private insolvency proceedings against the employee’s assets or compulsory enforcement measures.
The Good Leaver is, as the name suggests, the opposite case. The employee is allowed to keep the shares saved until he leaves. This can be just a part or all of the shares.
In some programs this is done via negative selection. That is, it is determined that all cases that do not constitute a bad leaver are automatically a good leaver. But here too, the good leaver cases should be regulated positively. For example, if you are unable to work through no fault of your own or are terminated by the employer (which cannot be influenced by the employee). In particular, the case of the employee resigning themselves – especially before the end of the vesting period – often leads to a need for discussion.
Gray Leaver and self-termination
As we know that the world is not just black or white, in many cases the intermediate stage of the so-called Grey Leaver established. Regulations of this kind should create a balance between: the company’s interest in retaining the beneficiary for as long as possible and the employee’s interest in receiving compensation (in the form of shares) for the services provided – but also in having the freedom to choose another one after a certain period of time to be able to search for activity.
Of course, it’s completely okay if someone decides to end their employment relationship with a startup – everyone is free to make this decision. And there are a whole host of reasons why someone might leave a startup. Sometimes family circumstances mean that you have to set up camp somewhere else, or an irresistible offer from another company beckons. The rule that allows a bad leaver to completely lose all shares seems too harsh here. But you shouldn’t forget: Investors and co-founders put their money into the company in the hope of a long and fruitful partnership. An employee, possibly in a key position, who throws in the towel without a good reason is not necessarily beneficial. Enabling a good leaver regulation instead is not always necessarily the right solution.
The Gray leaver, which usually comes into play when the employee resigns, can therefore be agreed upon as a middle ground between good leavers and bad leavers. That is, the beneficiary does not have to return all, but a larger part of its shares as the Good Leaver.
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In this context, so-called Fade-out regulations agreed: If, for example, a beneficiary has received all shares after the vesting period has expired and then leaves the company, these shares already received will be reduced again to a certain basic value if the exit takes place some time later.
This regulation is often used to ensure that Employees do not leave the company immediately after their vesting period has expiredbut continue to have an incentive to stay with the company in the long term.
Avoid undue discrimination
Ultimately, the company is free to determine which cases should be treated as bad leavers and which should be treated as good leavers or gray leavers. Freedom of contract fundamentally applies here. It can therefore be agreed individually under which conditions the shares should be reverted, as well as under which conditions the employee may keep the shares in whole or in part.
The only important thing is that the regulations comply with the so-called Transparency requirement suffice. This means that the regulations clearly and unambiguously indicate in advance the conditions under which the employee has to return the shares – or which conditions must be met in order for him to be allowed to keep the shares allocated to him.
Freedom of contract is a valuable asset here. However, it is restricted by the so-called prohibition of unreasonable discrimination, which applies specifically to employees. So it represents one of the leaver regulations an unreasonable disadvantage and the case comes before a German labor court, there is a risk from the company’s perspective an ineffectiveness of the relevant regulations. In case of doubt, the beneficiary receives his maximum claim. This applies primarily to regulations that provide that self-termination, regardless of time, will result in the complete loss of the shares, as this can be a so-called inadmissible hampering of termination. Reason: the employee then refrains from terminating the contract so as not to lose the virtual shares he has already earned.
To put it clearly: Legally, a lot is possible here, especially with virtual shares. This is mainly due to the fact that beneficiaries do not make a separate payment for shares, but rather this as an additional component for their activity and performance for the company receive. Even extreme leaver regulations based on the US model, which stipulate that beneficiaries completely lose their virtual shares if they leave the company – at whatever point in time – can therefore be agreed without their ineffectiveness being set in stone from the outset is.
A question of culture
This is not just about legal questions, but also about how the company wants to position itself overall and what corporate policy decision should be made:
Pure exit-driven, venture capital-financed companies certainly take a different approach than companies that not only provide for exit-related regulations, but also, for example, for beneficiaries to participate in profit distributions. The approach taken here is that the beneficiaries, who have worked for the company for a few years, have of course paid their dues for the shares and are therefore allowed to keep them even after leaving the company.
Beyond all the legal subtleties in the program (Bad Leaver, Good Leaver, Gray Leaver, Fade Out), one thing is crucial: all supposedly harsh regulations, which only pursue the interests of the company and investors, have missed their meaning and purpose at the latest. if they achieve the opposite and demotivate employees from the start.
The decisive factor when designing leaver regulations should therefore be to what extent they can actually be influenced by the employee (performance, company loyalty) or cannot be influenced (illness, occupational disability, termination by the company). Excessively harsh regulations have a negative impact on the corporate culture and the motivation of employees.
Clear communication is important
Ultimately, the question of whether the beneficiary can influence the decision usually also arises if the company is sold by the founders and investors before the end of the vesting period. Straight weil This circumstance cannot be influenced by the employees, it is regularly agreed here that all shares vested become („Accelerated Vesting“). However, this usually happens in connection with a so-called “post-exit period”, during which employees continue to commit to working for the company.
An example: The vesting period is four years. This means that the shares actually only become valid after four years. However, the company is sold after two years – but employees still receive all shares directly through accelerated vesting.
As with other design options for participation programs, the same applies in the case of leaver and vesting regulations: Management must weigh up which design fits the corporate strategy and philosophy – and communicate this accordingly to the employees.
Disclaimer: this article does not constitute legal advice. Individual advice is required to design a program.
About the “Easy ESOP” authors:
Kolya Chudnokhovsky is a (serial) entrepreneur, angel investor and co-founder of ESOP-Direkt. Concepts for fair and economically attractive incentives for employees were close to his heart early on. When introducing our own participation programs, he observed that inadequate advice, a lack of transparency and serious errors in the implementation of participation programs were no exception. At ESOP-Direkt he is responsible for the further development of the project and its offerings and is in close contact with startups and SMEs.
Dr. Christopher Hahn is a founding partner of trustberg, lawyer, business angel and co-founder of ESOP-Direkt. As a lawyer, he focuses on corporate law, M&A and venture capital. Christopher Hahn has been an expert in the field of employee participation for several years and, among other things, wrote the standard work “Virtual Employee Participation” for Springer Gabler. At ESOP-Direkt he is responsible for corporate development and the design of the investment programs.
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