Good v.s. Bad Leavers – Clauses Explained for Startups
Not understanding the consequences of good and bad leaver terms, especially if they are not employee friendly, can cause a decline in morale, unhappy alumni, bad employee branding for the company and difficulties in managing the option program.
The biggest opportunity for companies lies in the freedom to choose their own good and bad leaver clauses. Every company can and should decide for themselves who is a good and bad leaver. However, this categorization should be done with an understanding of the consequences it may have on present, departing and future employees.
Who are good and bad leavers?
An employee becomes either a good or bad leaver once they leave the company. These two terms are ways to categorise the consequences on the employee’s vested and unvested share options when leaving the company. This classification is not a reflection of the employee’s personal character.
Bad leavers
The most common bad leaver classification is the termination of employment for cause e.g. misconduct, fraud, breach of law, breach of any agreement or material damage. Termination for cause can also be used for bad performance but isn’t always done so.
Sometimes a bad leaver can even be classified as someone who leaves the company before the vesting period is up. This practice is not recommended as it can create a feeling of unfairness, especially if the terms haven’t been clearly communicated to the employee upfront.
Bad leavers lose both their vested and unvested options which means all the options they earned during their time in the company, will be taken away. Vested options are the options that have already been earned and unvested options have not yet been earned. It is crucial that employees understand the magnitude of these terms before leaving the company.
Good leavers
The most common way of defining a good leaver is saying it is anyone who is not a bad leaver. It is often easier to clearly define the few cases where the employee might be classified as the bad leaver, rather than trying to count all the possible scenarios for both good and bad leavers.
When a good leaver leaves the company, they get to keep their vested options and only lose the unvested portion of their options.
Bad Leaver Example:
Upon joining the company, Eve was offered an option grant for 400 options, vesting over 4 years.
Unfortunately she came to work one day intoxicated and was thereafter fired for misconduct. She had worked for the company for 2 years and during that time 200 options vested for her.
As misconduct was one of the reasons an employee could become classified as a bad leaver in that company, Eve lost both her 200 unvested options and also her 200 vested options. All these options went back to the company’s option pool to be used for future employee grants.
Good Leaver Example:
Upon joining the company, Paul was offered an option grant for 400 options, vesting over 4 years. Paul stayed with the company for 3 years and during that time 300 options vested for him. After 3 years, Paul decided to go and work for another company.
According to the first company’s policy, all voluntary leavers were classified as good leavers. Paul got to keep his 300 vested options, but lost the 100 unvested options. The 100 unvested options went back to the company’s option pool to be used for future employee grants.
What is the Impact on the Employee?
The impact of the good and bad leaver policy varies depending on the terms and how well these terms have been communicated to the employee.
Employees who are classified as good leavers, get to keep their vested options. These are the options they have already earned. If an employee is a good leaver, the only consequence is that they will have to consider when and how they can exercise their options.
Bad leavers, on the other hand, face more significant consequences. Being classified as a bad leaver means losing both vested and unvested options.
Losing vested options means the employee forfeits any potential financial gain from those options. They will not be able to buy out the shares promised to them with the option agreement or sell the shares for profit. Therefore being classified as a bad leaver can be a considerable setback for an employee, both financially and in terms of their overall share ownership in the company.
For this reason it is essential for employees to understand the terms and conditions of their stock options. If they are not aware of the good and bad leaver policy before leaving the company, they might lose their options due to a legality. This in turn can cause dissatisfaction towards the company and a general feeling of unfairness. It is always better to educate employees beforehand on the implications of different terminations to avoid scenarios where the employee doesn’t understand the consequences of their actions and as a result becomes adversarial towards the company.
What is the Impact on the Company?
The impact of the good and bad leavers on a company can be significant as well.
The existence of good and bad leaver clauses can influence employee morale. If employees see the terms as unfair, it can lead to dissatisfaction towards the company compensation philosophy and contribute to a higher attrition rate.
The manner in which departing employees are treated, particularly bad leavers, can also impact the company's reputation and employer branding. If word gets out that the company penalises employees unjustly, it may discourage potential candidates from considering employment with the company. Negative employee experiences can harm the company's reputation, making it harder to recruit talented individuals in the future.
Clearly defined and thought through good and bad leaver clauses are also crucial for effective management of the company's share option plan. Effective management helps ensure fairness and transparency in the treatment of employees. In addition it provides clarity to the company's human resources and legal teams when handling employee departures.
Building Good Culture:
Part of coming up with employee share option plan’s terms and conditions is predicting what kind of impact they could have on your company’s culture and whether the values of the plan align with that of your company.
To foster a positive work culture and avoid potential pitfalls associated with good and bad leaver terms, companies should above all consider fair treatment, communication and education.
Companies should strive to create good and bad leaver clauses which are fair and balanced. Minimising the amount of bad leaver scenarios and making sure employees get what they deserve shows the company in a good light and could help attract and retain talent. E.g. it isn’t necessary to have voluntary leavers categorised as bad leavers.
If an employee has been a superstar employee for 3 years but the vesting schedule was 4 years and suddenly they wish to leave the company, then leaving doesn’t reduce the impact they had in building the company for those 3 years. If the company truly values its employees, the bad leaver terms will reflect it by not being overly penalising towards the employee.
In addition to having a good bad leaver policy, companies can build good culture by effectively communicating the terms of their stock option programs to employees. This includes clearly explaining the good and bad leaver clauses, vesting schedules, and the overall value of equity compensation. Providing educational resources or workshops on these topics can help employees make informed decisions ahead of time.
Conclusion
Understanding and properly managing good and bad leaver clauses is crucial for both employees and companies. Not comprehending the consequences of these clauses can lead to decreased morale, negative employee branding, and difficulties in managing option programs. By defining their own good and bad leaver clauses and ensuring fairness and transparency, companies can foster a positive work culture, attract and retain talent, and effectively manage their share option plans. Clear communication and education regarding these terms are essential to ensure that employees are well-informed and can make informed decisions about their options.
