As emerging companies advance and grow, they often confront unique challenges that require recruiting new team members or letting go of others. While parting ways with an existing employee should mark the endpoint of a relationship, failing to follow the proper procedures can mark the beginning of protracted and expensive litigation. Conferring with counsel can ensure that a startup avoids costly litigation, secures company property and information, and sets a professional and reliable precedent for dealing with future employees. Here are six considerations startups should take into account when an employee leaves their business.
Whether an employee leaves voluntarily or is terminated for cause, it is important to document the reasons underlying the end of the employment relationship. While most employees are classified as “at will,” meaning they may be let go for cause or without cause, federal and state law often prohibits terminating an employee because of his or her membership in a certain protected class. Furthermore, unemployment agencies or future employers may request that a company provide an explanation for the employee’s termination. Properly documenting the reasons why an employee is leaving the company may not only protect the interests of the company, but also help preserve goodwill by easing the transition for the former employee.
Planning ahead and mapping out what to say to an employee who is leaving the company can make the difference between a disgruntled former employee and someone who promotes the company’s mission even after moving on. More importantly, some states mandate that employers must provide departing employees with certain disclosures or statements. For example, California requires that employers give employees written notice of changes in the employment relationship when employees are discharged, are laid off, or experience other certain changes in employment status. Employers may also need to deliver to the employee information regarding continued health insurance coverage or COBRA, disability coverage, company provided life insurance, 401(k) information, and other employment benefits. By showing former employees that their interests are valued even as they are leaving the company, employers can help promote goodwill.
For many emerging companies, the company’s most valuable property may be intangible. When an employee helps develop the company’s intellectual property (IP), it is important to ensure not only that he or she returns all tangible documents and materials, but also that the employee keeps company secretes confidential. The first step to securing company IP is to require employees to sign a Proprietary Information and Invention Assignment Agreement (PIIAA) when they are first hired. Such an agreement requires employees to assign to the company valuable IP that they generate that is relevant to the company’s business. The company can then reinforce the protection of its IP by requiring departing employees to sign termination certificates attesting to the fact that the employee is not in possession of confidential documents or materials, certifying that the employee has complied with the terms of the company’s PIIAA, and that the employee has agreed to preserve as confidential any information relating to the company that was disclosed in confidence during the employment.
Ultimately, protecting the company’s IP is an important reason to for an emerging company to confer with counsel at both the beginning and end of an employment relationship. This is particularly important because states may have strict guidelines as to what types of IP employers can require their employees to keep confidential or assign to the company. As a result, an overly broad PIIAA may be difficult to enforce in court, thereby leaving valuable company property unprotected.
Your company can also help protect its interests by requiring that a departing employee refrain from soliciting remaining company employees or, in certain jurisdictions, from joining another firm that competes with the company. In order to protect against poaching from competitors, companies can require employees to sign restrictive covenants such as non-compete agreements or non-solicitation agreements. While a non-compete agreement precludes a former employee from joining a company that works in the same or similar field, a non-solicitation agreement prohibits the departing employee from recruiting other employees they leave behind.
While non-disclosure, non-compete and non-solicitation agreements can be vital to protecting your company’s interests, some states, including California, prohibit non-compete provisions extending beyond the term of employment other than in certain limited circumstances and disfavor extended non-solicitation agreements. Moreover, states such as California have even been known to interpret overly broad confidentiality agreements as unenforceable in their entirety if such agreements are viewed as inconsistent with a state’s public policy interests. In the startup industry, where employees from all around the country regularly work together on one-of-a-kind projects and where a company’s most valuable asset is its intellectual property, an unenforceable restrictive covenant can dramatically undermine a company’s prospects. For these reasons, working proactively to draft enforceable restrictive covenants with outside counsel can help protect a company’s value.
Employee compensation in the emerging company world can be complicated. Because startups are often short on cash, many utilize a variety of compensation strategies to reward employees. It is vital that a company properly calculate what is owed to a departing employee. Specifically, a company should be aware of state law obligations regarding pay accrual and unpaid wages, unused vacation time or paid time off, or unpaid earned bonuses and commissions. Startups should recognize that each state applies different timelines for when employers must deliver such compensation to employees. While some states, such as California, generally require all unpaid compensation to be paid on the last day of employment, other states impose three-day deadlines, while others impose longer and more complicated deadlines based on the type of compensation being paid or the reason underlying the employee’s termination. Employers should also consider whether offering a severance package is appropriate. While severance packages are more common for executives and high-level managers, severance can be a helpful incentive to motivate a departing employee to sign a release of claims in favor of the company and leave on more positive terms. By discussing such issues with a lawyer who specializes in employment compensation and benefits, emerging companies can not only ensure that they fulfill their promises to their employees but can also maintain a positive reputation in the community from which they plan to recruit future employees.
Many emerging companies rely on equity-based compensation, such as stock options and restricted stock, to motivate employees to contribute to the growth and success of the company. However, navigating the technicalities involved in utilizing equity-based compensation can be complicated. Any stock option subject to vesting immediately stops vesting on the date the recipient’s employment relationship ends with the company. So a company should calculate the amount of vested options a departing employee holds based on the vesting schedule set forth in the option agreement in order to understand what such employee may still be able to exercise. In addition, the departing employee’s ability to exercise the vested options he or she holds expire after a specified time period following the end of the employment relationship. This period generally varies based on the circumstances of the employee’s termination (e.g., whether an employee is let go with or without cause or whether the employee leaves the company because of disability or death). Similarly, restricted stock grants subject to vesting will also stop vesting when an employee leaves the company. With stock options, an employee automatically loses the ability to exercise any vested options after a certain time period following departure. However, with restricted stock grants, companies are often required to proactively invoke the company’s right to repurchase the unvested restricted stock. Because repurchase options typically have complicated notice requirements as well as specific deadlines, companies should confer with counsel as soon as the company determines an employee is departing. When a company misses a repurchase notice deadline, it may forfeit the ability to repurchase unvested restricted stock, leaving a departing employee in possession of shares he or she otherwise would not have been entitled to. Counsel can help navigate the process of securing unvested equity grants as well as updating an emerging company’s capitalization documents in order to ensure that the company’s ownership records stay organized.
As the above six considerations illustrate, there are many issues to consider when an employee leaves a company. These issues and the corresponding guidance can change depending on the individual facts and circumstances surrounding each specific employee’s departure. As a result, companies, especially startups should always consult with a lawyer to ensure they are taking all appropriate steps and thinking through all necessary issues to comply with applicable laws and protect the company’s IP, reputation and equity whenever an employee leaves.