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Employment Contracts with Founders and Key Employees

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Employment Contracts with Founders and Key Employees

Postby Pinskylaw.ca » 27 Jan 2016, 10:34

In many situations involving investment in the startup by venture capitalists, the investors have bargained and paid for the right to control the startup. Although a founder bears the greatest managerial responsibilities, care must be taken that these responsibilities do not restrict the investors' bargained right of control beyond the limitations agreed upon by the parties. The employment agreement with the founder should not be used to settle control issues that are typically addressed in the shareholders' agreement. The employment agreement should clearly specify that the employer's failure to pay stipulated compensation, or the startup's breach of the shareholders agreement, are the only causes of breach. In addition, the agreement should recognize that the employee is always subject to policy decisions of the Board of Directors and that the Board of Directors may change duties from time to time. A floor on the level to which the founder's authority or rank can be reduced is sometimes set. This may be especially important in later years when managerial, rather than technical/scientific, capabilities become more important.

As in the case of the founder, the agreement with key employees should specify the position the key employee is to occupy, the scope of his duties, and that he is subject to the control both of the Board of Directors and the senior officers designated by the Board. Those key employees who are to work full time for the startup should agree to devote their energies exclusively to the startup affairs. However, the participation of scientists (either the key employees or founders) in outside, non-pecuniary activities, such as the preparation of papers, participation in conferences and colloquia and retaining teaching positions at major universities, may be to the advantage of both the employee and the startup. Excessive participation in these activities, however, invariably reduces the employee's value to the startup since the work of key personnel rarely stops at the end of the business day. Proving whether any of these activities adversely affects the employee's full-time performance during normal business hours is difficult. The contract should therefore preclude all outside activities within the area of the employee's expertise, whether or not for profit, and where appropriate enumerate as exceptions those activities permitted without the startup's consent. Notification of all such activities should be required.

Many key employees and founders have substantial outside affiliations that they (and the startup) may find useful to retain. In these cases, an agreement providing for part-time employment or a consulting arrangement may be more appropriate. Part-time employment, however, complicates both the protection of the startup's trade secrets and the procedures ensuring that the startup is not using the secrets of others. If the employee simultaneously works for others in the same field as that of the startup, it may become exceedingly difficult to prevent the employee from wrongfully using the startup's secrets in his other work or to ensure that inventions and other intellectual property developed by the employee for the startup are not deemed to be the property of another. These risks are easier to protect against in the case of a full-time employee. In that case, the startup can ascertain what the employee knows and can better prove wrongful misappropriation of secrets by a future employer after termination of his employment.

Naturally, an employment agreement must specify the salary and other compensation to be paid the founder or key employee. Compensation arrangements vary widely and may include a base salary combined with cost-of-living escalators and incentive compensation. Deferred compensation may also be useful to ensure the loyalty of the employee. Fringe benefits may include both those uniquely tailored to the employee, such as life and disability policies funded by the startup, as well as general benefit plans providing for life, health and disability insurance and pension and profit-sharing arrangements. The contract may also require the startup to provide a car and specify business expense reimbursement procedures. However, since most startup companies are unprofitable in the early years, equity and profit participation replace the more generous salary and compensation arrangements for founders and key employees. Equity participation through share purchase, share bonus, or share option plans will typically set forth a schedule whereupon the equity participation is dependent upon continued employment of the employee. Although the employment agreement can set forth the specific terms of the equity participation, separate agreements such as share option plans, share option agreements, and share purchase agreements are usually prepared.
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