I
n the early stages of a company’s life, issuing shares (primarily to early investors and to employees) is a vital cog in the machine that we considered last month. Every cog considered in this series of articles requires maintenance. A drag-along right (from the September issue) should be checked periodically, and after any big event in the company’s life, to make sure it still fits the company’s situation – and altered if it doesn’t, rather than trying to alter it when an exit deal is on the table.
The company’s shareholder base, however, requires ongoing maintenance and should be provided for in the company’s articles of association. Investors will understand that the company has issued equity to earlier investors and employees, but they will be wary of the problems that can be caused by ex- employees, or third parties to whom employees have transferred their shares. Many corporate actions require all, or a certain percentage, of the company’s shareholders to approve them – these shareholders are far more likely than employee shareholders to have moved without telling the company (so no paperwork can reach them), lost interest in the company entirely (so that they ignore it) or, if they left on bad terms, actively seek to prevent the deal.
NoStick Ltd.
It is common that a company adopts “leaver provisions” in its articles of association, which are provisions that compel an employee to sell their shares to the company or its shareholders in the event that their employment ends. Generally they divide the employees into “good leavers” and “bad leavers”, depending on the circumstances in which they leave, and then provide that bad leavers receive only nominal value for their shares but good leavers receive a fair market value. There are many variations on this theme, from vesting schedules through to multiple classes of leaver, but the aim of the provisions is always to ensure that when employees leave they can’t take their shares with them.
NoStick Ltd. had leaver provisions in its articles, and had several employee shareholders who were allotted and issued shares by the board.
One employee shareholder left the business on bad terms, and dealing with various other aspects of that departure unfortunately meant that the share transfer paperwork necessary to recover his shares was forgotten.
After
leaving the business, he had no interest in signing the necessary paperwork, and ignored all communications from the company.
NoStick could sue the ex-employee – he is in breach of the articles of association until he hands over his shares.
The time and
money cost of doing so, however, would be significant. If the business is bought then the operation of the drag-along right will forcibly transfer his shares – but that may not be for some time. In the meantime, the ex-employee remains a shareholder and is entitled to vote, receive dividends and so on.
The usual
structure of leaver provisions is such that if the leaver retains their shares having left the business, there is little that the company can do to compel them to sell - companies usually ensure that the share transfer is on the table at the same time as the employee’s compromise agreement – and before they get whatever payment they are receiving in connection with it.
This approach, however, fails in a situation where the leaver’s shares are worth more than the severance payment, or no payment is being offered. A better approach is to have employees to whom shares are issued sign a simple document that gives any director of the company from time to time power of attorney only in respect of their shares, in the event that the leaver provisions are triggered.
This
means that a director can sign share transfer paperwork on the leaver’s behalf – even if the transfer is left until after the actual departure. This provision cannot be in the articles of association – a power of attorney must be a deed – but such a limited agreement should not be objectionable to an employee about to receive equity in the business.
NoReserves Ltd.
Another point in which leaver provisions often fail is the identity of the buyer. Ltd. had standard leaver
provisions, and when an employee shareholder came to 31 entrepreneurcountry NoReserves
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