While a lot of effort is invested in selling the potential upside of the startup to recruit key employees who can add value to the business, often less attention is placed on the employment terms on which those individuals are engaged. That approach is understandable – by its very nature, founding a business requires total commitment and comes with uncertainty – papering that reality can feel unnecessary, particularly when parties’ approach new ventures with rose-tinted lenses. However, paying attention to the fine print in key employees’ contracts can be particularly helpful when startups prepare for later funding rounds (as investors are likely to require that key employees are engaged on robust terms committing them to the business) or, more importantly, to better protect the business as employees’ roles develop or they subsequently leave the business. Common pitfalls when negotiating employment contracts with key employees can be easily avoided and taking sufficient care early on can massively protect the value of the business going forward.

Remuneration and incentives

It is not uncommon for founder or senior management employment contracts to not specify the salary the individual will receive. The main up-side for founders and senior employees joining a startup business lies in the equity they receive rather than their monthly pay-check. There is often an understanding that the fluctuating profitability of startup businesses means that executives’ salaries are dependent on the success of the business. However, even where founders or senior employees may be initially comfortable with that risk, taking this approach exposes the business to unpaid wage claims being brought subsequently or national minimum wage enforcement action by HMRC. Deciding to backpay wages once the business becomes more profitable may not serve as a silver bullet, particularly given the potential criminal liability attached to non-compliance with national minimum wage legislation (and the public relation impact as well).

Some startups seek to address this matter by outlining the equity being granted to senior leaders in their terms of employment. However, this approach does not satisfactorily address the potential risk of unpaid wage claims or strictly speaking, comply with minimum wage legislation. In addition, this method also muddies the waters between the standard terms on which equity is being granted to employees and each employee’s individual entitlements. Particularly as startup businesses go through various funding rounds and growth cycles, investors will often propose new terms in relation to employees’ equity (e.g. resetting the vesting of any options the founders or senior employees hold). Hardcoding provisions relating to such employees’ equity in their employment contract risks cutting across the option agreements or plan rules that have been implemented or amended and may allow departing employees to claim that, under their employment contract, additional options have vested compared to what the startup accounted for – this scenario usually plays badly with investors who are increasingly focussed on governance in startups.

Business protection provisions

When papering senior employees’ terms of employment, there are a number of key provisions startups will want to ensure are in place to protect the business. These include:

• Confidentiality: ensuring senior employees are subject to robust confidentiality provisions that last both during and indefinitely following the termination of their employment. While employees have implied duties of confidentiality during their employment, including explicit provisions that relate to the entire business (along with customary provisions relating to return of company property) will serve startups well when employees’ contracts are terminated and when the arrangements are diligenced in future funding rounds
• Intellectual property: introducing explicit intellectual property rights assignment obligations. As with confidentiality provisions, employers have some protections in the UK as intellectual property rights created by employees in the course of their employment are deemed to automatically belong to their employer. However, startups should still consider including broader provisions assigning intellectual property and building in a mechanism for the startup to assign intellectual property rights on behalf of employees. Particularly for startups whose predominant value lies in their ownership of intellectual property rights, having detailed provisions that give founders and investors sufficient comfort will serve those businesses well in the long-run
• Termination levers: including additional levers to manage employee departures will position startups well to deal with employee who have resigned or are being terminated by the company. In particular, including explicit flexibility to pay employees in lieu of their notice can ensure a swift departure if an employee is being disruptive to the business. In the same vein, having the explicit option to place employees on garden leave can help protect the business by preventing them from joining a competitor or frontloading expectations regarding employees providing handover services. To cater for more drastic circumstances, including a comprehensive list of events where the startup can dismiss the employee without notice (e.g. serious misconduct, repeated failure to exercise their duties or their actions that have an adverse reputational impact on the business) can nip conduct or poor performance issues in the bud
• Restrictive covenants: tying senior employees to post-termination restrictions. While the policymakers around the world are increasingly taking tougher stances on the enforceability of non-competes (and similar restrictions), the UK still permits non-competes and non-solicits that are well drafted. Including these provisions in senior employees’ agreements can, in practice, serve as a way to deter them from potentially damaging the startup’s interests by immediately competing or poaching other key employees once they leave the business (or at the least, gives startups leverage when negotiating employees’ departures)

Founders establishing and developing their businesses seek to address challenges of the current climate while building for the future as well. Taking a considered approach to how startups’ key talent will be engaged by the company (and their terms of employment) often allows a win for all parties – i.e. clarity for employees regarding their terms of employment (and compliance with applicable law), protection and future-proofing for startups managing their key employees and transparency and comfort for investors looking to protect their stake.