What You Should Know about Involuntary Termination of Employment Transfers
Let’s talk about involuntary transfers related to termination of employment or membership interest.
When key employees, contractors, or advisors leave a closely-held company, it’s crucial to have a clear plan in place for handling their shares. This means ensuring that departing individuals are required to sell their shares back to the company.
Without proper documentation, such as specific provisions in employment contracts, you risk complications with company control, decision-making, and ownership structure.
Let’s explore what needs to be included in your governing documents to protect your business and maintain alignment among your shareholders.
How to Make Sure Departing Employees Sell Their Shares Back to the Company
What are the steps involved? There are provisions that should be documented in both the employment contracts and the company’s governing documents. From notice periods to the mechanics of share buybacks, we’ll cover everything you need to know to protect your business and maintain control when key team members exit.
Read Transcript
Hi, thanks for tuning in to another dose of Bite-Sized Bits of Knowledge, where we give you meaningful information in a short amount of time. We’re almost done with the transfers segment, and we’re still on involuntary transfers and we’re breaking it down today. We’re going to talk about termination of employment, okay, or termination of membership interest.
In the former case, sometimes it’s very common to give key employees or key contractors – key advisors – some shares of the company. We talked about it in another video, there’s different kinds of ways of doing it. You can give them voting, non-voting, you can give profits, interest, shares. There’s a lot of ways to do it.
But suffice to say there needs to be documentation that when they are no longer employed that they have to sell their shares back. Because for the same reasons of disability and death, you don’t want to have a former employee still owning shares. This is not a publicly traded company with a big market for selling and transferring shares. You want to keep it in-house. You want to keep it small.
And I don’t think you want to reward a former employee any more than we’re contemplating here today. So when an employee, contractor, advisor, et cetera, departs, usually that’s tied to a trigger that says you have to sell back your shares to the company. And we’ll talk about the mechanics of that in another video.
Let’s talk about – usually, an employee or advisor has a contract, okay? If this is done correctly, you should have your governing documents and you should have your employment agreements, used loosely, separate because they’re different. And regardless, you should have provisions in them that say that upon termination, you’re subject to the transfer rules and the governing document. Now, those transfer rules should be for an employee, contractor, or advisor. They should have something called, loosely speaking, good notice, bad notice, good notice, bad notice.
Good notice means, “Okay, you give us ample notice as defined in the agreement. That way we can find someone to replace you and we can train them and we can kind of minimize the disruption to the business by your departure. Obviously, you’re an important person to the company if you have shares, so it’s going to take time to replace it.”
So giving good notice is what we’re contracting to do in the document so that it minimizes disruption. And if you do good notice, then the terms of the sale will be more favorable to you as the departing employee, contractor, or advisor.
On the other hand, if you give bad notice, which is basically this violating your notice provision, not giving enough notice, screwing the company, leaving them shorthanded to have to figure out hiring and training, then that’s going to be a less favorable transaction to sell the shares back.
I mean, you’re entitled to – in my view of the world, this person who’s departing is entitled to the fair value of their shares. I’m just talking about the terms of how they get it and whether or not they get it more favorably, less favorably based on how much notice they give you.
It’s important because, you’ll see, when we talk about the mechanics of how the sale works, it’s another way that bad notice could really burden the business. And so it’s very common and good agreements are contemplating these kinds of ideas, okay?
The next video we’re going to talk about is going to be on some complications with transfers and the mechanics of transfers, so I’m really excited to get into that one. Don’t forget to download our business planning stress test if you have not done so already. It’s free. As well as our Florida formation checklist and some other goodies that you’ll find linked below. Thank you for stopping by and stay tuned for more.
As we mentioned, it’s common for employees or contractors to be granted shares in a closely-held company, but when they leave, those shares should be repurchased by the company. This process needs to be clearly outlined in the governing documents, including employment contracts.
It’s essential to have provisions in place that require employees to sell back their shares upon termination. Let’s dive deeper into what should be documented in the employment contract and why these provisions are so important.
What to Include in the Governing Documents
One key document is employment contracts. Employment contracts can include details of specific conditions about resignations, notice periods, or stipulations of a notice such as the minimum period an employee must work before they resign. It is in this documentation that you should also include if former employees are to sell back their shares after termination.
In Florida, these are typically manifested through two-week period notices. It is not a legal requirement because the at-will employment doctrine allows employees to resign at any moment without notice, but it can be input in the employment contract.
Why Is Documenting Important for Shareholders?
Aside from the complexities of tax implications, ensuring former employees know it is in their employee contract to sell back their shares is important in maintaining control and simplifying management.
In a closely-held company, ownership and control are often closely linked. You want to avoid a situation where former employees can possibly retain significant control in the company after they have left. This can cause potential issues with decision-making and voting rights.
The fewer people who have ownership responsibilities, the easier it is to manage the company’s operations. With too many shareholders, you risk potential misalignment on company goals.
Protect Your Business with Clear Terms
Having clear provisions in your employment contracts is essential for managing your company. Ensuring that departing employees or contractors are required to sell back their shares helps avoid potential complications related to decision-making and ownership alignment. By documenting these rules upfront, you protect your business from disruptions and maintain an effective management structure.
If you’re unsure whether your employment agreements are fully protecting your company’s interests, don’t hesitate to reach out. Our team is here to help guide you through the process and ensure your company is set up for long-term success.
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Originally published 03/10/2022. Updated 12/16/2024.
Author:
Barry E. Haimo, Esq.
Haimo Law
Strategic Planning With Purpose®
Email: barry@haimolaw.com
YouTube: http://www.youtube.com/user/haimolawtv
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