This article was originally written for and featured in Director of Finance.
Businesses looking to grow and develop will often bring in new senior-level personnel, with specialist knowledge to help the business move forward.
Shares or options might be part of the deal, or a bonus will be the preferred incentive. The individual may be offered a seat on the board. When all you want to do is look forward to the honeymoon, taking steps to protect your business in the event of a divorce is often far from an owner’s thoughts.
However, as with pre-nuptial agreements entered into before real marriages, taking those steps avoids potentially damaging problems and risk to your asset if there is a falling out: the old maxim act in haste, repent at leisure is never more pertinent.
What should the owner of a business in this position consider for its pre-nup (which will usually in practice be contained in a number of documents)?
The new arrival’s employment contract must contain a number of key clauses.
It goes without saying that good protections against unfair competition, such as well-drafted restrictive covenants (non-compete, non-solicit of and non-dealing with customers, and non-solicit of key employees) and a detailed confidentiality clause, are vital.
But in addition a couple of other protections should be considered.
A garden leave clause allows the individual to be kept in employment but away from the business for his notice period, provided that is not too long.
Without such a clause, any enforced garden leave will almost certainly be a breach of the employment contract, which the individual can accept and leave employment without those well-drafted restrictive covenants applying to him.
A payment in lieu of notice clause allows the business to bring the employment to an end immediately, without there being a breach of contract, by making the payment set out in the clause.
This payment should be salary only for the notice period, and could be paid in instalments and be made subject to an obligation on the individual to mitigate his loss if the clause is drafted in that way.
Any bonus scheme must also address what happens on departure. The best solution is to ensure that the scheme rules or the individual’s contract contain a provision requiring him to be in employment and not under notice given or received on the payment date in order to receive any bonus.
Such a “killer clause” is effective, and an important protection.
Where shares or share options are concerned, the key concern is what happens when the employment ends. Having clear rules about forfeiture and retention is essential forward-planning.
Will the individual be allowed to keep his shares or must he offer them for sale? Will the price depend on the reasons for his departure, with a bad leaver, dismissed for misconduct or some other good cause, receiving par value, and a good leaver being paid fair value, perhaps discounted in the early years?
Will share options be forfeited as a bad leaver but continue to be held if a good leaver? Perhaps any retained shares or share options should be forfeited if the individual competes with the business after he departs. All need to be considered.
If the new arrival becomes a director, his easy removal in the event of a split becomes of paramount importance.
A clause in the company’s articles of association allowing the majority shareholder to remove a director at any time simply by depositing a notice at the company’s registered office ensures that an owner who retains a majority shareholding can effect removal at any time.
This avoids the time-consuming Companies Act removal procedure. Without such a provision, the individual would also remain a director until removed, and would usually have to be invited to board meetings, failing which any business at those meetings would be invalid.
It goes without saying that retaining a majority on the board, or at least a chairman’s casting vote if numbers are equal, is also essential pre-planning for an owner.
All of these areas are areas of risk for owners of businesses.
Dealing with them at the outset avoids potential loss of control and ultimately possible loss of a valuable asset if things go wrong. These pre-nup provisions are essential!