In the excitement of getting new business ventures off the ground, the formalities of employment relationships can be overlooked. Taking the time to implement employment contracts at the beginning can be very valuable and avoid big headaches down the road.
Here are some things to consider:
In the early years of a start-up, compensation often consists of low salaries with higher proportions of equity-based compensation or bonuses if/when certain growth targets are met. If a start-up is successful, these types of incentive compensation can involve large amounts of money. Without clarity on the terms under which incentive compensation will be earned and paid, disputes can result in expensive legal challenges.
We recommend being specific regarding:
- targets for earning incentive compensation;
- a method or formula for determining the value of the incentive compensation when the target is met;
- the form of compensation (usually cash or equity);
- whether the incentives will be paid all at once or vest over time; and
- whether the employee will be entitled to any portion of the incentive compensation if their employment ends before it is fully earned or paid.
Protecting Intellectual Property
It is important for start-ups to be able to protect any innovative ideas, products or services they are developing or introducing. We recommend including explicit terms outlining confidentiality obligations and protecting the business’ rights to intellectual property developed by their workforce.
New ventures often operate in a highly competitive space. Poaching talent and enticing clients to switch providers is commonplace. We recommend that start-ups consider including strong non-solicitation restrictions (and in some circumstances non-competition provisions) in employment agreements.
Planning for Growth
Some start-ups will experience exponential growth in short periods of time. Significant changes in the scope of an individual’s role and responsibilities can impact the enforceability of certain terms in a contract, most notably provisions limiting an employee’s right to notice or pay in lieu of notice on termination of employment. This risk can be reduced with provisions which expressly acknowledge the likelihood of a change in role and responsibilities as the company grows and which provide for reasonable notice of termination of employment.
Planning for Acquisition
The growth plans of a number of start-ups include a goal of being acquired by a larger player in the space once they reach certain thresholds. Even if it is not the intention of the start-up, it will often be the result over the short to medium term. In those circumstances, it is useful to have “change of control” terms built into employment agreements. These define the circumstances that will trigger the change of control provisions and the employee’s possible rights to compensation when a change of control occurs.