A company will unlikely want key employee shareholders or other service providing shareholders (i.e. company founders) to stop providing services. If this happens, the shareholder is referred to as a Leaver and the other shareholders will not want the Leaver to retain his or her shares in the company. This is because the shareholders will want to be able to offer those shares to another potential employee needed to replace the Leaver.
Leaver provisions intend to retain shareholders who provide valuable services to the company. Start-ups commonly include these terms in their shareholders’ agreement to keep their original team in place in the early development stages, and support growth.
How Do Leaver Provisions Work?
The company issues shares to the shareholder at which point, he or she enters into a shareholders’ agreement. If, however, the shareholder commits a particular act (a ‘Leaver Event’), it will then have to offer some or all of its shares for sale to other shareholders or the company. Generally, a schedule in the shareholders’ agreement contains how many shares the Leaver must sell following a Leaver Event. If the Leaver Event occurs,
- Within one year, the Leaver must sell back all of his or her shares;
- Between one and two years, the Leaver must sell back 75% of his or her shares;
- Between two and three years, the Leaver must sell back 50% of his or her shares;
- Between three and four years, the Leaver must sell back 25% of his or her shares
- After four years, the Leaver can retain all of his or her shares.
The date is from the date of the shareholders’ agreement.
What Constitutes a Leaver Event?
The provisions of the shareholders’ agreement determine what constitutes a Leaver Event. They also incorporate the concept of a Good and Bad Leaver Event.
A Bad Leaver Event includes some or all of the following:
- a shareholder materially fails to provide, or consistently fails to provide in a proper or timely manner, the agreed services to the company;
- a shareholder breaches a material clause of the shareholders agreement;
- a shareholder knowingly acts or causes others to act, in a manner that is reasonably likely to impair the reputation, value, profitability or goodwill of the company; or
- a shareholder attempts to dispose of shares other than by the process outlined in the shareholders’ agreement.
The shareholders’ agreement will define a Good Leaver Event as the shareholder ceasing to provide services to the company for a reason other than because of a Bad Leaver Event. It captures resignation and redundancy.
At What Price Does the Leaver Have to Sell its Shares Following a Leaver Event?
A Leaver will likely have to sell some or all of his or her shares to the company or to other shareholders. The share’s purchase price differs depending on whether it is a Good or Bad Leaver Event.
A share’s purchasing price following a Good Leaver Event is a price agreed between the parties or the shares’ fair market value as determined by an independent valuer (the Purchase Price).
Following a Bad Leaver Event, a share’s purchasing price is often a discounted Purchase Price. The parties determine the discount amount. However, it should not be too excessive as to be unreasonable. Market practice is generally the Purchase Price less a 20% discount.
Leaver provisions can encourage loyalty among key shareholders who you do not want to stop providing services to the company until a certain period has passed.
If you would like any additional information about leaver provisions or shareholders’ agreements, or require any assistance with advice or drafting, please do not hesitate to contact us at LegalVision. One of our business structuring experts would be delighted to assist you!