Many startups and investors overlook the critical issue of what happens to a company’s shares when a key player leaves. Here let us look into the leaver provisions that play a crucial role a company’s definitive agreement. These provisions are often overlooked in the definitive agreements although they are crucial for safeguarding companies from potential disruptions when a shareholder takes an exit. By establishing a clear framework on how a departing shareholders’ shares are to be treated based on the nature of their departure, these provisions carve the difference between an orderly transition and a messy corporate divorce.
What are Leaver Provisions?
Leaver provisions are clauses in shareholder or employment agreements that manage share ownership and determine what happens to a shareholder’s equity when they leave the company, impacting the remaining shareholders. These provisions categorize departing shareholders as either Good Leavers or Bad Leavers, depending on the circumstances of their exit.
Good Leaver
Good leaver provisions typically apply to shareholders who exit the company under favorable or unavoidable circumstances which are beyond their control. These circumstances include retirement at or after a specified age, death, severe mental or physical disability, redundancy, voluntary resignation for a good reason and any such circumstances. Good Leavers mostly receive favorable treatment from the company and are often awarded the fair market value for their shares at the time of their exit.
Bad Leaver
Bad leaver provisions come into play when a shareholder exits the company under unfavorable conditions, such as termination for gross misconduct, fraud, breach of duty, or criminal conviction related to their role or any such other circumstances. They also apply to cases of resignation to join a competitive business, violation of contractual obligations, or any other actions that become detrimental to the company’s interests as outlined in the shareholders’ agreement. Bad leaver provisions are designed to protect the company and the remaining shareholders from situations where an outgoing shareholder impairs the company’s interests or violates their contractual obligations.
Need for Leaver Provisions in Shareholders Agreement
Leaver provisions are essential in the shareholder agreement, and play a crucial role in maintaining a company’s stability and subsequent growth. The effectiveness of these provisions extends beyond mere contractual terms, directly impacting the company’s operations, culture, and long-term prospects.
One key function of these provisions is to protect the company’s interests by ensuring that a shareholder’s exit does not negatively impact the business or the remaining shareholders. The leaver provisions outline mechanisms to prevent situations where a departing shareholder might retain majority shareholding or voting rights, which could hinder the company’s future operations.
Leaver provisions also play a significant role in maintaining control over the company’s ownership structure. They give remaining shareholders or the company the opportunity to buy back the shares of the departing shareholder, effectively redistributing ownership among the continuing members. This helps in keeping the ownership concentrated within the company and the existing shareholders.
From a financial perspective, these provisions are crucial for attracting new investments. Well-drafted leaver provisions provide potential investors with a reassurance that the company has robust mechanisms to handle disputes arising from a shareholder’s exit. Additionally, these provisions offer a clear framework for addressing complex situations, as they define the terms of exit in advance, significantly reducing the likelihood of conflicts or disputes when a shareholder leaves the company.
Fate of a departing shareholder’s shares depending on whether they are classified as a ‘Good leaver’ or a ‘Bad leaver’
When a shareholder departs from a company, the leaver provisions in the shareholder agreement come into effect. The treatment of the departing shareholder’s shares depends on their classification as either a “Good Leaver” or a “Bad Leaver.”
For a Good Leaver, the shares are typically valued at fair market value. This value is determined either by a pre-agreed formula or an independent valuation. Following this, the company and existing shareholders have the option to buy back the shares at fair market value. In certain cases, such as retirement or ill health, Good Leavers may also be allowed to retain their shares.
For a Bad Leaver, existing shareholders are typically given the option to buy back their shares, often at very low prices, such as nominal value or the original purchase price. The company itself may also buy back the shares at a nominal price and hold them as treasury shares, which can later be used for employee stock option schemes or redistributed among employees. In some cases, the company may also forfeit the shares, especially the unvested shares, or cancel all shares of the Bad Leaver with no compensation provided. Companies may also adopt a combined approach, where vested shares are bought back at discounted prices while unvested shares are forfeited without compensation. This approach depends on the framework established in the company’s articles of association or shareholder agreement.
Conclusion
In a nutshell, leaver provisions serve as a critical safeguard for the company and existing shareholders when a shareholder holder departs. By clearly outlining the terms of departure and the treatment of shares for both Good and Bad leavers, these provisions protect the company’s interests, maintain stability, and provide a framework for managing ownership transitions. Good Leavers are typically rewarded with fair compensation for their shares, while Bad Leavers face severe consequences for the discouraging actions that could have put a detrimental affect on the company. As businesses evolve, well-crafted leaver provisions remain essential for supporting the company’s long-term vision and ensuring smooth transitions during complex ownership changes. These provisions are powerful tools that shape a company’s culture and shareholder behavior.
