In our article on founder agreements here, we gave a high-level overview of the concept of “good” and “bad” leavers. This is an important aspect of inter-company relationships and governance and often poses the question - what happens when a shareholder leaves the business? This is a prevalent issue in many private companies, particularly founder-led and high-growth businesses, as shareholders are often employees or provide a service to the company.
It’s at cessation that leaver provisions can become commercially critical. Usually contained within a company’s articles of association, shareholders’ agreement or share option documentation, these provisions establish a contractual framework for dealing with shareholder exits and protecting the long-term interests of the business.
What are leaver provisions?
Leaver provisions are contractual mechanisms that regulate the consequences of a shareholder ceasing to be involved with a company. They commonly apply where the shareholder is also an employee, founder or director, although they can also extend to consultants or option holders.
Typically, the provisions distinguish between a “good leaver” and a “bad leaver”, with the classification determining how the departing shareholder’s shares will be treated. In many cases, the provisions require the outgoing shareholder to transfer some or all of their shares to the remaining shareholders or the company itself.
There is no default position under English law. Without express drafting, a departing shareholder will usually remain entitled to retain their shares regardless of whether they continue contributing to the business. It’s therefore important to, at the early stage of the business, have the correct principles and related procedure in place within the company’s constitutional documents or an individual’s service agreement.
Types of leaver:
A good leaver is generally someone who leaves in circumstances outside of their control or in circumstances considered commercially reasonable. Common examples include death, ill health, redundancy or retirement. A good leaver will often be entitled to receive fair market value for their shares, or to retain some of their equity interest.
A bad leaver, by contrast, is usually someone who departs in circumstances viewed as damaging to the business. This can include resignation without notice, breach of restrictive covenants or competing with the company. In these situations, the leaver may be forced to transfer their shares at a discount, sometimes as low as nominal value or the lower of that amount and the original acquisition price.
A third category, being “intermediate” leavers, deals with the treatment of shareholders who are neither a good nor a bad leaver. For example, they resigned after an agreed period of service, or their employment was terminated for redundancy reasons. In such cases, the price payable is often linked partly to market value and adjusted by reference to a vesting schedule reflecting the individual’s tenure and period of share ownership.
Commercial importance:
Leaver provisions play an important role in maintaining fairness and commercial alignment within a business.
If an individual leaves shortly after receiving shares but retains full ownership, this can create a number of inter-company issues (namely amongst executive members of the business) and could also undermine future growth, particularly for entities looking to raise money. Incoming investors will often expect robust leaver protections to ensure that key individuals remain appropriately incentivised over time.
These clauses also provide certainty. By establishing a clear process in advance, the parties can reduce the likelihood of disputes concerning ownership, valuation and transfer rights when a departure occurs. This is particularly important because shareholder exits are frequently accompanied by strained relationships and differing expectations as to what is “fair”.
Key drafting and negotiation points:
Poorly drafted leaver provisions can create ambiguity, disputes and, in some cases, enforceability concerns. Particular attention should therefore be paid to:
- the precise definitions of “good”, “bad” and “intermediate” leaver;
- the valuation methodology for departing shares;
- whether compulsory transfers apply automatically;
- how the provisions interact with employment contracts and share option schemes; and
- whether the company itself has the ability to buy back shares.
Care also needs to be taken to ensure the provisions are commercially proportionate and properly structured from a legal perspective, particularly where significant value may be forfeited by a departing shareholder.
The role of Culbert Ellis
At Culbert Ellis, our corporate team regularly advises founders, investors and management teams in different sectors on the drafting and negotiation of shareholder arrangements and articles of association (both generally or in the context of, for example, a funding round), where within good leaver and bad leaver provisions will commonly be contained.
How To Get In Contact
To find out more or if you require assistance with these matters, speak with our Corporate Team on +44 (0)204 600 9907 or email info@culbertellis.com.
Accurate at the time of writing. This information is provided for general information purposes only and should not be relied upon as legal advice.
