Nothing ignites frustration in deal negotiations quite like leaver provisions. You’ll find leaver provisions in venture capital deals, private equity buy-out structures, employee incentive schemes, and sale and purchase agreements in an M&A deal. In fact, they are relevant in any scenario where employees, founders or other key people hold equity interests whilst performing services to the equity issuing company. One can construe leaver mechanisms in many ways, and what is considered ‘market’ covers a wide spectrum. Achieving a solution that will satisfy everyone can be a real challenge, given that leaver provisions attempt to strike a balance between protecting shareholders’ investment and allowing management some flexibility in how and when they can exit the business and still get a proper return for their efforts. This article features the myriad of leavers and their treatment, the pricing on exit and the enforceability of leaver provisions. Overall and in the aftermath of the pandemic, ICT, biotech, and healthcare continue to be the most active sectors in terms of PE transactions.
Classification and Treatment
Classifying leavers can be challenging, because one never knows from the outset the exact circumstances of a leaver’s exit. There are no hard and fast rules about leaver exits, and it always depends on the specifics of the transaction and the company.
The company will usually want to define bad leavers as those who are not (classified as) good leavers. Company founders, employees or other corporate officers will seek the inverse and identify the circumstances in which they would be a bad leaver, without which they would be good leavers.
Good leavers are usually those who leave the company on good terms following an event of death, redundancy, mental or physical incapacity impairing their ability to work, or departure following a change in the role or job description and duties. Bad leavers are usually those who leave the company on bad terms following conduct (they allegedly committed) that is detrimental to the company’s reputation or business. Some examples of such conduct include being a party to fraudulent activities, breaching contracts or the shareholder agreement, acting beyond the remit of their authority or being dismissed for gross mis-conduct. The company might also want to include a more flexible discretionary leaver provision—for intermediary leavers—that allows the company’s board of directors to determine on a case-by-case basis whether a shareholder is considered a good or bad leaver.
With the categories of leavers set, the drafting of the provisions should clarify how each type of leaver is treated when they leave the company. Executives could be in such a strong negotiation position that they can retain some or all of their shares, depending on the timing of their exit and as long they are not bad leavers. In such scenario, (a) the leaver could be entitled to retain an increasing proportion of his or her shares over time, perhaps that convert into non-voting shares, (b) the leaver could keep the shares that have been vested, as they represent his or her contribution to date, or (c) the leaver could transfer the shares to a Stichting Administratiekantoor (STAK). If the leaver must put some or all of his or her shares for sale or agree for them to be repurchased by the company (subject to the procedure of purchase of own shares), the debate then shifts to the price at which the leaver must sell the shares.