Leaver provisions – balancing founder fairness and company protection

In venture capital deals, leaver provisions play a critical role in managing the departure of a founder or key employee. These provisions are designed to safeguard the company’s equity structure and ensure that shares remain in the hands of those actively contributing to the business. However, they must also balance fairness to founders, particularly in cases where a departure is outside their control.

Leaver provisions set out what happens to a departing individual’s shares, distinguishing between “good leavers” and “bad leavers”, and defining the terms under which shares can be repurchased or forfeited. 

This article in our ‘Anatomy of a term sheet’ series, explores why these terms are a key focus of term sheet negotiations and are integral to aligning the interests of founders and investors.

What are leaver provisions?

Leaver provisions determine the treatment of a founder’s shares when they leave the company. They categorise leavers as either:

• Good leavers: typically, those leaving due to reasons beyond their control (e.g., illness, death, redundancy, or retirement). Good leavers are often allowed to retain their vested shares or sell them at fair market value.
• Bad leavers: typically, those leaving voluntarily or being terminated for cause (e.g., gross misconduct). Bad leavers generally forfeit unvested shares and may have vested shares repurchased at nominal value.

The purpose of leaver provisions is twofold:

• Incentivising commitment: ensuring that founders and key employees are committed to the company’s long-term success.
• Protecting the cap table: allowing the company to redistribute shares to active contributors or use them to attract new talent or investors.

Key components of leaver provisions

Vested vs unvested shares

• Unvested shares: typically forfeited upon departure, regardless of whether the leaver is categorised as good or bad.
• Vested shares: the treatment of vested shares depends on the leaver’s classification:
  
  • Good leaver: may retain vested shares or sell them at fair market value.
  • Bad leaver: vested shares are often repurchased at nominal value to minimise their financial benefit.

Repurchase mechanism

Leaver provisions usually grant the company or remaining shareholders the right to repurchase shares. The purchase price depends on whether the leaver is a good or bad leaver.

Example:
•    Good leaver: fair market value.
•    Bad leaver: nominal value (e.g., £0.01 per share).

Time-based gradation or vesting

Many leaver provisions include time-based gradation, which adjusts the treatment of shares depending on how long a founder has been with the company. This approach recognises the contributions of founders who have been actively involved in building the business over a significant period, while still protecting the company in its early stages. 

The standard vesting period is four years, with the first tranche often subject to a one-year cliff.

Triggering events

Common events that trigger leaver provisions include:

• Voluntary resignation.
• Dismissal for cause.
• Death or incapacity.
• Retirement.

Practical considerations for leaver provisions

Defining good and bad leavers

The distinction between good and bad leavers should be clearly defined to avoid disputes. Grey areas, such as voluntary resignation due to internal conflicts, should be addressed during negotiations.

Protecting the company’s equity

Leaver provisions ensure that shares do not remain with individuals who are no longer contributing to the company’s success. This is particularly important in the early stages when equity is a critical resource for attracting new talent or investors.

Avoiding punitive terms

While leaver provisions must protect the company, overly harsh terms can discourage founders or key employees and undermine trust. Investors should consider the long-term implications of punitive clauses on morale and retention.

Board discretion

Term sheets often include a clause allowing the board to exercise discretion in determining leaver status. While this provides flexibility, it can lead to conflicts if decisions are perceived as unfair.

Analysis: founders’ perspective vs investors’ perspective

In summary

Leaver provisions are a cornerstone of venture capital deals, balancing the need to protect the company’s equity structure with fairness to founders. By negotiating clear and equitable terms, founders and investors can ensure that these provisions support the company’s growth while avoiding unnecessary disputes.

Read the next article in our "Anatomy of a term sheet" series, we’ll explore drag-along, tag-along and co-sale rights, examining how these provisions protect both majority and minority shareholders in exit scenarios. 

If you're navigating the complexities of venture capital term sheets or preparing your business for investment, our experienced team is here to help. Get in touch to discuss how we can support you in securing the right deal for your business.