In M&A transactions involving the acquisition of a stake in a company by a private equity fund, it is common for the founder to retain a minority shareholding and remain involved in the management of the company for a specified period. As the founder’s continued involvement is often important to the investor, it is essential to regulate the consequences of their potential departure. To this end, shareholders’ agreements often include Good Leaver and Bad Leaver clauses, which govern the consequences of such departure and the conditions under which the investor may acquire the founder’s shares.
Although these clauses are not subject to specific statutory regulation, their drafting requires particular care to avoid disputes. The following sections examine five key aspects to consider.
1. Precisely define Good Leaver and Bad Leaver events
Bad Leaver events are typically associated with voluntary departure before the end of the agreed commitment period or serious breaches of obligations, such as fraudulent conduct, a fair disciplinary dismissal, or breaches of exclusivity or non-compete undertakings.
Good Leaver events generally cover circumstances beyond the founder’s control, such as death, incapacity, or termination of their employment or service relationship without just cause.
It is essential to avoid ambiguous definitions, particularly given the financial consequences of being classified as a Bad Leaver, and to ensure that these provisions are consistent with the founder’s employment or service agreement.
2. Properly structure the Call Option over the shares
To enable the investor to acquire the founder’s shares following their departure, a Call Option is commonly agreed. The exercise period and procedure, the shares subject to the option, and the conditions for completing the transfer should be clearly specified.
The Call Option must also be coordinated with the transfer restrictions established in the shareholders’ agreement and the company’s articles of association, particularly lock-up provisions and pre-emption rights. Otherwise, conflicts may arise that hinder the exercise of the option.
3. Properly regulate the purchase price of the shares
The purchase price is one of the most sensitive aspects of the negotiation. In Good Leaver scenarios, it generally corresponds to fair market value, whereas in Bad Leaver scenarios, a lower price may be established, potentially linked to the nominal value of the shares, to encourage compliance with the founder’s obligations.
For Good Leaver scenarios, it is advisable to determine how fair market value will be calculated, either through a previously agreed formula or by appointing an independent expert. For Bad Leaver scenarios, consideration should be given to whether the reduction in price is proportionate to the seriousness of the breach.
4. Address the consequences of an incorrect Bad Leaver classification
In private equity transactions, the investor often has greater bargaining power. Accordingly, the clauses may allow the investor to exercise the Call Option upon the occurrence of the triggering event, without waiting for a court ruling. The difficulty arises if it is subsequently determined that the founder should not have been classified as a Bad Leaver.
For example, if the shareholders’ agreement identifies a fair disciplinary dismissal as a Bad Leaver event and allows the Call Option to be exercised upon notification of the dismissal, the investor could acquire the shares before a final court judgment determines that the dismissal was unfair. To address this situation, the parties may agree on compensation for the founder equal to the difference between the price actually received and the amount they would have received as a Good Leaver. This facilitates the founder’s exit while protecting their financial interests in the event of an incorrect classification.
5. Provide mechanisms to facilitate the transfer of shares
Regulating the departure events and the purchase price is not sufficient: mechanisms should also be established to facilitate completion of the share transfer. One possibility is for the founder to grant an irrevocable power of attorney in favour of the investor to execute the share purchase when the agreed conditions are met. However, the irrevocable nature of such a power must be legally justified and comply with applicable legal limitations, with the powers granted and the circumstances in which they may be exercised clearly defined.
Conclusions
Good Leaver and Bad Leaver clauses play an important role in private equity investments where the founder’s continued involvement is relevant to the continuity of the business.
Properly negotiating and drafting these clauses requires a thorough understanding of these mechanisms and their legal implications, as well as striking a reasonable balance between the investor’s interest in ensuring the stability of the business and the protection of the founder’s rights.
Ultimately, the objective is not merely to encourage the founder to remain involved in the business, but also to establish mechanisms that allow their potential departure to be managed with legal certainty while minimising the risk of future disputes.
Article published in Ejecutivos
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