From time to time I’m approached by a small company that has given an employee partial ownership in the company. While I haven’t yet had one written on the back of a bar napkin, the agreements usually aren’t much more sophisticated than this (or formal either). By the time I’m consulted, like many once-good marriages, the employment relationship has ended the employer would like to have the former employee out of the company’s ownership structure. What is the company to do? Unless the company has the right to buy the employee out, the employer may be left with a carrots and sticks strategy.
Anytime you consider granting an employee partial ownership in the company, you should retain a lawyer experienced in drafting these kinds of arrangements. The lawyer will ensure that the appropriate documents are drafted that provide the employer the right to buy-out the employee’s interest upon the occurrence of certain triggering events such as the termination of employment. The documents will likely provide a clear and specific manner of valuing the employee’s interest. Inevitably, the agreement will contractually require the employee to assign his or her interest back to the company in return for the required payment.
If you lack good contractual documents, you’re left with carrots and sticks. By that I mean that the employer may be left having the employee agree to return the interest either by paying more than what the interest might be worth (i.e., the carrot) or holding the employee to all of the obligations that ownership of the company might require (i.e, the stick).
The best course of action is to spend the effort on the front end and have the agreement written in such a way that the employer and employee recognize the benefits of partial ownership but provide a clear and meaningful strategy for the business divorce if and when the employment relationship ends.
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