Employment Matters – Get It In Writing
Presumably in an effort to save cost and due in part to a “less is more” attitude, founders will from time to time avoid entering into written agreements that they believe are unnecessary to advance the business or protect their interests or the interests of the startup company. An agreement regarding employment matters often falls into this pile, and this failure to enter into a simple agreement with co-founders or company employees will from time to time present real problems for a startup company down the road when a dispute arises concerning employment, compensation or rights upon termination.
It is for this reason that I generally recommend that founders get it in writing – enter into written employment arrangements with your co-founders and with future company employees to clarify roles and responsibilities, expectations concerning compensation and benefits, rights (or lack thereof) upon termination, and associated rights and obligations (e.g., stock option grants and non-compete arrangements). Depending on the specific circumstances, this may also include entering into written employment arrangements with your co-founders upon formation – that’s right, even when there is no money in the bank – addressing, among the other elements in the employment arrangement, the founders’ agreements and expectations regarding accrued salary (or, more likely, the waiver thereof) between formation and initial funding. For a startup, employment arrangements can be boiled down to a simple offer letter, often no more than 1-2 pages, containing the following essential elements:
Duties. The offer letter should briefly describe the employee’s position with the startup and his/her duties, the person that the employee will report to (or, if applicable, reference reporting to the Board for certain executives), and should provide necessary flexibility for the company to modify the employee’s duties and responsibilities from time to time.
“At-Will” and Term. The offer letter should specify that the employment arrangement is “at will”, not for any specified period of time, and subject to termination by either party for any or no reason. I often see startups get stuck in negotiations among co-founders and startup employees regarding severance upon terminations “without cause” or for “good reason” and I believe startups should avoid severance provisions in offer letters to the greatest extent possible. Startups just don’t have the funds to deal with severance payments to terminated employees (regardless of why someone is terminated), and in light of the critical role each employee plays a startup needs the flexibility to swap out its people to drive success even if it simply a matter of “fit” and not “cause”.
Compensation/Benefits. The offer letter should specify the employee’s base salary (or, if an hourly employee, the hourly wage and applicable hourly work schedule), any bonus arrangements (specifying whether bonuses are purely discretionary or, if not, the specific formula, milestones and bonus amounts applicable in each year), and any benefits an employee may be entitled to receive (e.g., health, dental, 401K, vacation, etc.). If you are entering into an offer letter at formation and prior to a fundraising, your offer letter should specify that the employee/founder is waiving any right to receive compensation until a specific fundraising milestone is met and that the founder’s equity is full compensation for services rendered during such period of time (and the offer letter should also reflect whatever has been agreed upon with respect to accrued salary – i.e., no accrued salary, partial or all, but only once a fundraising happens). Many if not most benefits will be covered in greater detail in an employee handbook or policy manual and in the specific plan documents for health, dental and 401k benefits, and reference should be made to such manual and plan documents in the offer letter. Since employee benefits are often changed, the offer letter should state that the company reserves the right to modify benefits (and, if applicable, compensation and bonus arrangements) from time to time as necessary or appropriate.
Equity Grants. If an employee is to receive a stock option or other equity right, the offer letter should specify the terms of such grant and any qualifications to such grant. Stock options must be granted by a company’s board of directors or a designated committee, and therefore the offer letter must be carefully worded so that the offer letter does not bind the company before the board or committee takes action. For example, an offer letter might say “Management of the company will recommend to the Board that Employee be granted an option to purchase 1,000 shares of common stock of the company at the fair market value determined by the Board, but Employee acknowledges that the Board is not required to accept management’s recommendation and that the Board retains the absolute discretion to determine the terms and conditions of Employee’s option grant, if any.” An alternative (and often preferable) approach is to create an effective consent process with the Board that would allow for approval of option grants in offer letters before the offer letters are sent to provide an actual commitment to an employee on the equity side.
Restrictive Covenant Agreement. Startups will typically want their employees to be bound by noncompetition, nonsolicitation, confidentiality and assignment of inventions covenants and it is recommended for enforcement purposes to have such agreements executed contemporaneously with and as a condition of employment. The offer letter should reference (and attach) a restrictive covenant agreement to make clear that it is being executed as a condition of employment.
Right to Work. The offer letter to contain verification language and, if appropriate, backup documentation supporting employee’s right to work in the United States (whether by citizenship, permanent residency or work visa).
Entire Agreement. The offer letter should make clear that it reflects the entire agreement between the company and the employee and that there are no other oral or written agreement relating to employee’s employment arrangements with the company. This provision is important to avoid the possibility that the employee might later claim that in pre-employment discussions management promised employee a certain type of bonus or other consideration that was not reflected in the offer letter.
