A good leaver / bad leaver clause is not just in the investor’s interest ?

After having outlined the good leaver / bad leaver clause in the agreements applicable to start-ups, let’s look in more detail at its purpose.

Provided it is properly drafted, this clause helps to protect the company’s interests by ensuring that the shares remain in the hands of those who are actively or financially involved in its growth.

When drafting and negotiating this clause, there are two main and often conflicting concerns to bear in mind:

1. Protect the interests of all shareholders, including active shareholders

On the one hand, when an investor decides to back a start-up, he is investing in a project but also, and sometimes even more so, in a team. He expects the founders to devote themselves fully to the project in an attempt to achieve the objectives presented to him. As a result, the investor’s return prospects are essentially based on the time and commitment of the founders or active shareholders within the company in the years following the investment. In addition, the realisation of the investment increases the latent value of the company’s shares, including the value of the shares held by the active shareholders. This is even truer when active shareholders take advantage of a financing round to monetise part of their shares.

On the other hand, when a founder decides to set up a company with other founders, he agrees with them on a shareholding structure which is conditional, even if it is not explicit, on their long-term commitment to the project.

This is first and foremost a question of fairness. Would it be fair for a founder who has worked for a few months in a start-up to keep the shares he subscribed to through a minimal contribution, compared with an investor who paid a lot more for his shares, counting on the promise of maintaining a team dedicated to a project? Would it be normal for this same founder to benefit, as a shareholder, from the capital gains generated by the work carried out by the other founders after his departure? Is it normal for him to benefit from the full value of his shares, while the other founders will have to work for years to create the value of these shares?

On a more pragmatic level, a good leaver / bad leaver clause ensures the continuity and stability of the company by providing for the possible purchase of the shares of an active shareholder who leaves the project. If an active shareholder leaves the company, a new incentive plan may have to be put in place to ‘incentivise’ his/her replacement (whether an existing founder or a third party). This clause means that the outgoing active shareholder’s shares can be used for this purpose, which is preferable to issuing new shares that would dilute all the company’s shareholders and create so called dead equity.

2. Guarantee fair compensation for the leaving founder

For the founder who is leaving the company, it is essential that the good leaver / bad leaver clause ensures that he receives fair remuneration for the work, capital and time he has invested in the company. This is because he has generally accepted limited remuneration for his services, and the shares he owns often represent a significant component of his personal assets. Whether he/she stays with the company or decides to leave, a founder therefore has a vested interest in protecting the value of his/her participation.

These two concerns come into conflict when it comes to negotiating the good leaver / bad leaver clause, as it directly affects the question of ownership of the leaving founder’s shares and their acquisition price. This is often a delicate subject that gives rise to heated discussions, as the mechanism provides for sometimes difficult departure scenarios that can have significant financial consequences for the leaving founder.

Our experience at Beyond has led us to tailor this clause to the circumstances of the transaction. The leaving conditions will vary according to the maturity of the company, the type and amount of the investment and the seniority of the founder. If the company is raising funds for the first time, the conditions will certainly be stricter for the founder, as the risk taken by the investor is high and the founder’s presence is crucial to the development of the project and therefore to the preservation of the investment.

If the company has several founders, it is essential that each of them approaches the leaver clauses as a potential leaving founder, but also as a potential remaining shareholder and therefore beneficiary of the purchase option. Balanced clauses can be in the interests of all founders and shareholders and reinforce the long-term stability of the company.