A subtle dance begins whenever a startup and an executive consider working together. Both the prospective hire and the startup want to make the right moves. Both want to protect their respective interests and avoid costly missteps.
My job is to guide them in completing that dance successfully. The goal is to help them live “happily ever after,” – whatever that duration may be. In the VC world, acquisitions can cause an executive position to be short-lived.
A clearly drafted Employment Agreement sets out the obligations and expectations of the company and the employee in order to minimize future disputes. While such negotiations can be difficult, setting expectations early and definitively builds the foundation for a long-term successful engagement.
That’s why I’m sharing a number of key considerations for any startup company negotiating an executive level employment agreement. The issues are similar for more established companies, with a few additional details which I won’t go into here.
Beyond the initial salary, there are several other factors to consider.
For starters, what is the mechanism for salary increases? Annually? Milestones? Up to the discretion of the Board? Same question with bonuses and follow-on equity grants.
A signing bonus should be considered, particularly if the executive is “leaving compensation on the table” at the previous employer.
If the compensation package includes a portion as variable compensation (e.g., a sales commission plan), that plan MUST be in writing. Negotiating one after the fact is almost always problematic.
In the current circumstances, special attention should be given to whether the executive’s salary may be reduced. While it is common for an executive’s salary to be reduced in only certain circumstances, in these times an executive might want to lead with their own salary cut in exchange for additional equity grants.
2. Scope of Employment – Don’t Over Negotiate
The scope of the employment and authority of the employee sets expectations. It is a good indicator of the “true level” of the executive and their expected working relationship with the C-Suite and the Board.
If the executive is the CEO, he or she absolutely must be on the Board of Directors and should be the Chair.
Any experienced executive is going to have industry and community contacts. Their ability to engage with those contacts (e.g., a directorship on another board, community activities, industry standards groups, etc.) and make personal investments is critical. It should be agreed upon in advance.
Certain other issues, such as job title, location, travel requirements, location and so forth should be discussed, but not necessarily put into the employment agreement. When negotiating an executive employment agreement, the key is to obtain the important items without overly negotiating the agreement or being too aggressive or pedantic. This negotiation will tell both parties a great deal about the other. While the executive should be firm, negotiating minutiae will make them seem small, rather than a leader.
3. Equity Grants
Equity grants are perhaps the most important part of the Employment Agreement. Key factors here include:
What percentage of the company as an equity grant is appropriate? There is some give and take with salary here. But a C-Level executive should expect a meaningful percentage of the company.
While an option grant is very common, I generally prefer that my executive clients receive a grant of restricted common stock outside of an option plan, as a typical plan doesn’t have enough available shares for a proper grant for an executive hire. I also recommend the company loan the executive the funds to purchase the shares to start the “capital gains clock ticking. This can be done with restricted common stock or an option grant, provided adequate shares are available in the plan and the grant allows for “early exercise,” which it should.
Most vesting occurs over a four -year period, with either a six-month or one-year cliff, and monthly or quarterly thereafter. More important than the strict terms of the vesting arrangement is the acceleration clause. While most executive level grants provide for “double-trigger” acceleration upon an acquisition, I generally ask, in addition to “double-trigger” acceleration, for additional “single-trigger” acceleration for a portion of the grant if an acquisition occurs within the first 18 months of employment.
Occasionally, one sees a company have the right to re-purchase shares upon the termination of employment. In the case of an executive, I never agree to this.
For a startup company, this conversation is more about the plans for the company in the coming years. I typically leave it with the executive being able to participate in the company’s benefit plans. For a more mature company, the discussion can be far more complex and in many cases, should be included in the employment agreement.
5. Liability Protection
Every C-level employee and Board Member should have an indemnity agreement, and the company must have D&O insurance.
6. Term and Termination
There are two schools of thought on termination provisions and whether the employment should be “at-will” employment. “At-will” employment is by far the most common, if not exclusive, employment status for startup companies.
If the employment is not “at-will” and is subject to a binding employment agreement, the term and termination provisions should be quite detailed and specifically negotiated. Common provisions include:
How long is the employment term?
What are the grounds on which the company can terminate the employee without cause or for cause?
What are the terms, if any, for compensation in the event of early termination?
Is the executive entitled to severance pay or payment of benefits, or COBRA benefits upon termination?
7. Post-Employment Limitations
While some employment agreements address post-employment restrictions, such non-compete provisions are not legal in California except in the context of a sale of a company. An executive should not agree to any post-employment restrictions, and the company should rely on the acquirer to restrict the executive’s post-employment opportunities. However, a non-solicitation clause is acceptable, as are confidentiality restrictions.
8. Miscellaneous Provisions
What is defined as a disability event and what happens on disability? Does the employee continue to retrieve salary and benefits for some period of time and for what period of a disability is re-instatement required?
Confidentiality and Inventions Assignments are standard and should be the same for all employees.
Should confidential binding arbitration be the exclusive way to resolve disputes? Is there an attorney’s fees clause where the prevailing party in a dispute would be entitled to recoup its attorneys’ fees incurred?
As you can see, there are many steps to completing a win-win employment agreement for both parties. When all involved are cognizant of the key negotiating points and bring realistic expectations, the chances are good that this “dance” will conclude successfully.