In order to ensure the structure, the company and the employee typically enter a so-called vesting agreement – stating that you must earn the full right to the securities by staying on and working for a decided time period.

Makes sense, right? So let’s say you are offered 500 warrants that you buy at fair market value (only offered as a management incentive so it’s only by accepting the vesting agreement you will get this opportunity), and that they will vest linearly (yearly) for five years. This means that every full year you have worked with the company will function as a milestone at which you  become the full owner of an additional 100 warrants.

Year           Non-vested          Vested

     0                    500                         0

     1                    400                     100

     2                    300                     200

     3                    200                     300

     4                    100                    400

    5                        0                     500                   

However – life happens and plans change. So, let’s say that, after three years, you have a heated fall out with the CEO and...

-        Scenario A

the CEO sends you packing, firing you on the spot, or

-        Scenario B

you decide to leave the company and instead start working with the biggest competitor as soon as the non-compete period that you have in your employment contract has ended.

So what happens to your warrants in each of these cases? You have fully vested 300 of the warrants – but how about the other 200 that you have bought at fair market and that are in your name, but subject to the vesting agreement? We could be talking about substantial monies. 

Do you get to keep them in part or in full? And if not – on what terms to you need to forfeit them? We will set the scene and then get back to the result in each of the scenarios.

So let’s set the scene by asking - who decides who is whom?

Good and bad leaver are contractually determined terms that the contracting parties will decide the definition of (in this case typically the employer will be the one setting the terms). When the incentive program is introduced the plan is that you will stay for the full period and earn all of your shares – they will be fully vested. In case you leave in advance, the parties will want to regulate the issue – you become a leaver. Typically the employer will feel that it is fair to treat you kindlier in case you leave because of e.g. illness or redundancy at work than if you decide to quit, or if you are fired. Hence the contract will typically define a number of scenarios where you qualify as a Good Leaver and a number of scenarios where  you will qualify as a Bad Leaver.

What is a Bad Leaver and a Good Leaver?

Good Leaver and Bad Leaver are the customary definitions in a vesting agreement of a person that leaves on good and bad terms respectively. Accordingly there is no legal definition governing this situation and you must review and negotiation your specific vesting agreement to ensure clear and fair terms.

Good leaver will typically represent a person leaving due to circumstances that he/she cannot control such as illness, death and being let go due to redundancy.

Bad leaver will typically be someone that quits at his/her own will or that commits a material breach of the employment contract or the vesting agreement.

What are the consequences in each case?

Typically the Good Leaver gets a better deal. It could be that it gets to keep a portion of the unvested warrants, or that he/she must sell them back at fair market value. The Bad Leaver will typically need to sell the unvested shares back at a heavily discounted price such as the nominal value (if shares), the acquisition value or eg 30 % of the fair market value.

Scenario A

In this case you are forced to leave and it is accordingly not under your control. Based on the definition of the Vesting agreement you are therefore defined as a Good Leaver – the contract then states that (i) you get to keep 3/5 of the warrants as they are already fully vested and as regards the non-vested shares you need to sell them back at fair market value so there is a loss coverage, but you lose the chance to be part of the upside – that could be substantial as mentioned.

Scenario B

In this scenario you decided to leave to go to a competitor. In this case, the 3/5 of vested shares for the first three years will be respected. You earned them before you became a Bad Leaver and they are out of touch for the company. The remaining 2/5 of the warrants you must however, according to the contract, give back at 30 % of the fair market value. This means that, if the warrants are of a significant stake and central part of your total compensation then you will have a significant down side to leave to the same work for a competitor but without the expected upside in a few years.

Sometimes a bad leaver also has a claw back where he must also sell back vested warrants/shares - so make sure to read the terms in detail.

Worst case scenario – cliff vesting

In some cases you have a so-called cliff vesting where you vest zero until the end of the vesting period. In the above case you would have zero at year three and lose all of your warrants. Only if you stay on until the end of year five would you have full control over your warrants.

In such cases – keep a close eye on the Good and Bad Leaver clauses so you don’t end up becoming a Bad Leaver losing out on that nice long term bonus of a couple of millions you were expecting.

A bridge - Sign-on bonus

A way to bridge loss of monies based on the bad leaver provisions, a  will be to demand a sign on bonus from your new employer and an incentive program that is at least as attractive as your current one. So if you stand to lose eg 2 MSEK worth of warrants then you demand 2 MSEK worth of warrants, cash or other securities in order to say yes.

What to look for when being offered an incentive program

If you are offered an incentive program or simply to become shareholder directly, ask your counterparty “what happens if I leave” and then check the response against the documents you have been presented to ensure that that there are no loop holes unmentioned. Are there any particular scenarios you worry about, ask extra. Perhaps you want to understand what happens with the vesting you are on maternity leave, leave of absence, or start working for a subsidiary. Five years are a long time so many things can happen that where perhaps not part of the mindset at the time the vesting agreement was written-  

What to look for when signing a vesting agreement:

1. Is the good and bad leaver clause clear and well defined so that you can understand it?

2. Is it reasonable?

3. What are the consequences of being a bad leaver?

4. What are the consequences of being a good leaver?

5. In case you disagree about someone being a bad (or good) leaver – what are the dispute mechanisms?

6. In case you disagree as regards the valuation of the securities, what are the dispute mechanisms?

7. What happens if the company is sold?

8. What happens if there is a merger between the company and another company?

Some additional things to consider

In case of any incentive program with a lock-in period, make sure you have a clear understanding also of the tax consequences as the base line will be that if you have vesting, the securities are yours due to your work performance and as such they should be subject to income tax and social securities for the company (however for warrants it is generally held that it is ok to have vesting terms and still have the securities be subject to capital gains taxes if the employee has paid fair market value for them when acquiring the warrants).

Stockholm, 2023-12-14

Author: Katarina Strandberg