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Questions and Responses from 7 September 2018

 Member-submitted question.

7 September 2018
Q:  Perhaps you could go over some of the mechanisms for poison pills in a founders’ agreement. I don’t know as much as I would like to about them, but I understand they are mechanisms to protect the company from hostile takeover, including takeovers engineered by one of the founders. I would just like to know a bit more about setting something like that up – or, from the other point of view, how such a thing could be de-fanged if one was the person hoping to sell out.
R:  When reading a prospectus this past week, one of our researchers uncovered this language which we’ve clipped for your interest.  This sets out the mechanisms that this particular company has used to protect itself from an unwanted takeover.  
Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of our company more difficult, limit attempts by our stockholders to replace or remove our current management and limit the market price of our common stock.
Provisions in our amended and restated certificate of incorporation and amended and restated bylaws to be effective in connection with the closing of this offering, may have the effect of delaying or preventing a change of control or changes in our management. Our amended and restated certificate of incorporation and amended and restated bylaws include provisions that:
  •   authorize our board of directors to issue, without further action by the stockholders, shares of undesignated preferred stock with terms, rights, and preferences determined by our board of directors that may be senior to our common stock;
  •   require that any action to be taken by our stockholders be effected at a duly called annual or special meeting and not by written consent;
  •   specify that special meetings of our stockholders can be called only by our board of directors, the chairperson of our board of directors, or our chief executive officer;
  •   establish an advance notice procedure for stockholder proposals to be brought before an annual meeting, including proposed nominations of persons for election to our board of directors;
  •   establish that our board of directors is divided into three classes, with each class serving three-year staggered terms;
  •   prohibit cumulative voting in the election of directors;
  •   provide that our directors may be removed for cause only upon the vote of sixty-six and two-thirds percent (66 2⁄3%) of our outstanding shares of common stock;
These provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any “interested” stockholder for a period of three years following the date on which the stockholder became an “interested” stockholder. Any delay or prevention of a change of control transaction or changes in our management could cause the market price of our common stock to decline.

Questions from 22 August 2018

 

Member-submitted question.

 

Q: In the services agreement on Clausehound: Complying with policies and procedures is a very general term. How can a consultant be aware of ALL policies and procedures? It takes a very long amount of time to achieve such familiarity. It also requires disclosure of such policies and procedures somehow.

 

R:  Although the contractor may not be aware of all policies and procedures, you can provide them with reasonable notice (that may possibly align with the notice of termination – e.g. the policy will not come into effect for 30 days, so that if the contractor is unhappy, they are able to walk away) on changes to any policies or procedures that affect this agreement. The employer can also offer additional compensation for signing the amendment to policy or procedure as additional consideration so there is no confusion that the new changes in policy are non-binding (under contract law in many jurisdictions, new terms that are struck after a deal closes that have no “consideration” are considered non-binding.  The topic of consideration is also discussed within our library for your reference). The employer may also require that the contractor go through additional training and sign off on some sort of acknowledgement regarding to the change in policy.

How are employees protected from changes to policy and procedure if they affect their work?

There are often policies to protect the employee – some of which required by law or for companies of a certain size. Whether or not they are specified in the contract, these policies are intended for the protection of the employee. If an employee is unhappy with policy or work procedure changes, they may seek to speak with an human resources representative of the company, an ombudsperson (if one is appointed at the company), who acts as an independent human resources advisor, or even reach out to government appointees regarding Human Rights protection. There may be rules from the local employment governing body to consider. If such policy changes create an adverse effect for the employee, the employee always has the right to decide on their feet to leave the place of employment if they are unhappy. It is important to note that, other than for human rights standards (which exist in many jurisdictions) the same protections will likely not apply to contractors who are considered temporary staff.  Employees are afforded a higher level of protection in most jurisdictions.

What is the purpose of an “No authorization to make decisions” or “No authority to bind” clause in a consulting or contractor agreement, or employment agreement?

This clause is intended to remind the contracted party that they are not signing officers of the company, and that they must ask an authorized signing representative of the company to “sign off” on company decisions. From time to time vendors will ask an employee or contractor to “sign off” on a decision, but they might not have the authority.  This clause serves as a reminder to such a party that they should seek permission from a higher ranking executive at the company.

Can you request IP rights now and in the future, for work done by your employee?

The language in an intellectual property (“IP”) transfer clause is often “aggressive” from the perspective of the company to make it clear that employees do not own any rights to IP created during the course of the agreement – not now and not later.   Note that this is different than taking IP in their future, not yet created work – that’s not the normal intent of a clause of this nature, the clause intends to create protection for work created TODAY (or during the course of the agreement).

It is important for the company to have that certainty to avoid any confusion or problems down the line because the company, when selling the IP, or when licensing it to a third party is often required to sign off that they have full ownership over the IP. However, if the employee disagrees and wants to carve out ownership of IP, they may certainly do so using a schedule to the agreement (decided normally at the outset of their working relationship) to stipulate what IP they own vs. what is owned by the company.

Member-submitted question.

Should a company pay a contractor in cash and shares?  

[HoundCo] wishes to receive the services of the Consultant for the purpose of accelerating the growth of [HoundCo], for which the Consultant shall receive, under this Agreement [cash compensation] [and a grant of options/shares in HoundCo pursuant to a separate agreement dated as of the date hereof].

A contractor agreement might state that the contractor has been granted shares separately and at the outset of the contractual engagement.  The contractor likely would not want to tie the share issuance to their ongoing work because this could result in the The share compensation is usually not dealt with in the contractor agreement, because there should be no concept of employee income associated with those shares, because you don’t know the value of those shares. Consult with accountant and tax lawyer that you are doing this properly.

What is the typical split between cash and shares for a contractor?

To learn more please take a look at this blog post about compensating new team members.

Would consultants be subject to vesting like employees? If they don’t consult for X number of years their shares are worthless?

The provisions of a share/option grant and vesting are normally the subject matter of a “share buyback” or “option” agreement, and often within those agreements there would be a triggering event such as failure to consult or reduction of hours beyond a certain point that would trigger a buyback or stop the vesting.  Make sure that you have checked these agreements carefully to confirm that they contain these provisions/protections.

Why are termination and renewal clauses in agreements? If both parties can terminate at any time, I don’t understand why it’s necessary to state an end date in any agreements  If both parties can terminate at any time, why is it necessary to state an end date in agreements?

A termination date creates an end date at which parties can decide whether or not to continue the engagement. With an automatic renewal – contractually – there is no real mechanism that is triggered. Practically, however, it is good to have an end date in advance to give both parties the time to determine next steps. They may decide to discontinue the agreement, and through an end date, parties should not get upset if the opposing makes this decision. On the other hand, the parties may use an end date to renegotiate the terms of the agreement, such as the number of hours worked or the hourly rate. Ultimately, without an end date, there is no natural point in time at which they can think through whether terms need to be changed or terminated.

Image result for startgbc logoMember submitted question

Q: Would owning company stock make the consultant have interest in the company even after a layoff? Would it constitute a breach of this agreement if the consultant joins another competing company after the stated non competition period?

A: If you mean a ‘financial interest’, yes owning stock at any time would give the consultant an interest in the company. That is the idea – that the consultant will be motivated to work hard to ensure that the stock will increase in value.

If hours are reduced, many stock vesting agreements would trigger a termination of vesting – so you would need to confirm this against your own vesting agreements/share buyback agreements to see what the result of reduced hours would be on the vesting schedule.

Q: ‘Can you own stock in the company and work for a competitor’

When a person leaves a company either through voluntary termination, layoff, requested termination or otherwise, unless specifically prohibited from doing this, yes, it’s fine to own shares in a company that you previously had worked for.  This is trickier where the employee is also a board member of the prior company because a fiduciary duty would exist to the shareholders of the prior company that could result in an actionable conflict between old company and new (best to resign from the board position.

Sometimes shareholder agreements will state that shareholders who are also consultants (or other key employees) cannot own shares in a competitor or work for a competitor while they are shareholders. In that case, there will be provisions for the company to redeem the consultant’s stock (shares). A non-competition obligation prohibits the consultant from engaging in any activities directly competing with the Business of the company during the term of the Agreement and for a limited time afterwards. After that time has expired there is no long a non-competition obligation. If you are concerned that ownership of shares in the company might violate a non-competition clause in the next consulting agreement, simple ownership of shares (if the shareholder is a minority shareholder without power to influence decision making) is not generally considered to constitute competition. Many agreements provide that ownership of less than a specific % of shares (e.g. 5%) for investment purposes does not constitute competition or a conflict.  

Best to discuss this with counsel to make sure you’re carefully navigating this situation.

Q: Isn’t it better to select a specific arbitrator to avoid leakage of confidential information before going to court or else?

A: If a dispute is resolved using the courts, information disclosed in court will be part of the public record, but confidentiality agreements generally provide that it is not a breach of the agreement to disclose information which is required to be disclosed by law e.g. a court. Parties can bring a motion before the court to limit the type and amount of information that is disclosed, and they can request that the court deal with certain matters ‘in camera’ i.e. not in public. The court will have to be persuaded that this lack of public disclosure is required in the circumstances.

It is likely correct that the arbitration process will roll out confidential information slowly and possibly under complete confidentiality.   In the early parts of the arbitration process, the only information disclosed to a potential arbitrators will be the name of the parties, the general nature of the dispute, and the time frame for scheduling purposes, giving the parties plenty of opportunity to negotiate a settlement with no information transferred.  Over the course of the arbitration a requirement for confidentiality can be placed upon the proceedings as well.

Q: What is an example of a conflict of interest in the business/consultant or business/contractor in this following scenario?

This question is intended to uncover what might arise as a conflict that this clause is intended to protect from?

Conflict of Interest. The Consultant warrants that the Consultant will report to [HoundCo] any instance of conflict of interest, as soon as the existence or potential for conflict of interest becomes known to the Consultant. Should [HoundCo] determine, after a reasonable period, that a conflict of interest exists or has the potential to arise, [HoundCo] will inform the Consultant of such decision, and the Parties shall make arrangements for another outside consultant to perform the Services.

Since consultants often work for a variety of clients, potential conflicts can arise. For example, if the consultant has confidential and competitive business information – that for such company provides a competitive advantage – that the consultant had obtained through another relationship, a potential conflict/issue could arise if they enter into a working relationship with a competitor that isn’t supposed to have access to the information.  Another example would be if the consultant is assigned to work for a competitor of another current or previous client of the consultant. While the consultant might be able to do their best for each client without violating any confidentiality obligations, the perception of a conflict will often make clients of the consultant’s employer uncomfortable. Sometimes clients will specify that the consultant cannot work for a competitor within a specified time period. A consultant may desire to charge more for this exclusivity.

Q: Does the Consultant hold the right to copyright their work? (i.e. if a website consulting company created a website, what sort of rights will they have over their work?)

A: The author of the material would have the original copyright. Consider this clause:

Licensing. The Consultant further agrees that to the extent that the Proprietary Information contains any intellectual property owned by the Consultant prior to entrance into this Agreement, the Consultant hereby grants to [HoundCo] a perpetual, royalty-free, worldwide license to (a) use, execute, reproduce, display, perform, distribute copies of, modify and prepare derivative works based on such material and (b) make, use and sell products and services under such rights, revocable only in the event of material breach of this Agreement.

The purpose of this clause is to have the consultant (who authored material before entering into the consulting agreement) give a license to the ‘employer’ to use the material as described in the license. This does not transfer the copyright, but grants a license to use the materials.

There is also significant writing within our library on ownership of pre-existing IP.

Q: How would you reflect project-based compensation (i.e, consultants getting paid for a project, not by hours)?

This can be done by changing the compensation in the Schedule to payment upon completion of the Services or completed Work Product. The agreement would then clearly have to describe what Services are needed to be completed or what the final Work Product would be, as well as the acceptance procedure, and once delivered and accepted by the company the contractor can be paid. A payment schedule can be added based on achievement of ‘milestones’ as defined in the project.

Q: Is it necessary to put the estimated number of years for which confidentiality is preserved?

A: Consider this clause:

Unless specifically authorized in writing by [HoundCo], either during the Consulting Agreement Term or after termination of the Consulting Agreement, the Consultant shall use best efforts to do all actions and take all steps to preserve the secrecy of the Confidential Information..

The Term of the consulting agreement should typically be included within the agreement. Whether or not the confidentiality obligation is limited by a stated period of years post termination is a matter of negotiation (and possibly a matter of local case law), but generally there is no reason that a secret should not be secret after a period of time.   The requirement to preserve confidentiality will depend on external factors too, including the employer’s obligations to their clients, which are also often unlimited in time. The consultant should and often contractually must be bound for a period of time that will match the employer’s obligations to their clients.

Q:  How would I change the contractor agreement to be applicable to a part time software developer?

This can be done by specifying that the services provided are relating to the software developer job title. In the expected hours section you can refer to part time hours between a certain range.

I hope these answers help! And thank you again for joining the Clausehound Online Negotiation Workshop on the Founder’s Agreement, and we hope it provided you with a valuable experience.

Our knowledge experts will work hard for you but we need to know how to do our jobs better. Our survey will take you less time than it takes us to answer one helpdesk question. Please provide us feedback – your time is appreciated!

Protected Relationships – what is best practice for this for both employers and contractors if it’s an industry where everyone uses the same relationships (e.g. software developers interacting with hardware manufacturers and media outlets). Is it best just to forgo this or limit it to a very specific agreed upon type of relationship that can immediately damage sales?

In the sample agreement, it seems like the Indemnity and Limitation of Liability sections are heavily skewed towards the employer. Are there typical fair clauses which a contractor may want to present to employers and that employers would typically agree to?

08 August 2018

Your Question: will be possible sign this contract in past date?

Yes! It is possible. Please see the now updated knowledge pointer included in the Founder’s Agreement on Clausehound. I’ve also included the knowledge pointer here:

Your Question: what best practice in situation, when we already run our business and not signed this type agreement yet?

Ideally, as soon as you can get to a written record is best practice. The potential to dispute the terms in the future is higher when there is no written record, especially if those terms have in fact not been agreed to.

Your Question: is Business Concept mean some document (presentation or vision document) which attached to this contract or this is simple text paragraph in definition section of contract?

We’ve updated the Founder’s Agreement to say “business of the company” on Clausehound. Take a look at the language on the Founder’s Agreement and see if this change has made the contract easier to understand.

Your Question: if one of the partners provide loan to company and want to get back this loan on next stage of investment with new investors (VC for example) how we could put this option to contract? Is it normal practice?

Yes, this can be included under the “Contribution” clause in the Founder’s Agreement. You can include special details about the type of contribution (e.g. loans, equipment, other capital contributions etc,). Please see here:

Your Question: Future Employee Interest – this is related to ESOP?

Yes this would be used, we’ve changed the clause to “Future Employee Stock Option Plan Interest” to reflect that this will be used for future employees.

Typically there are 3 mechanisms that are useful to protect existing shareholders’ from a rebalancing of shares without permission.

(1) shareholder or director approval requirements (2) right of first refusal, and (3) pre-emptive rights.  

Some but not all of these are in the standard founders agreement.

We’ve updated and simplified the Founder’s Agreement to include a clause (“Transfer of Interest”) that requires consent and the above 3 mechanisms to further protect existing Founders’ interest. We’ve included the updated clause here.

 Member submitted question

Can you add co-founders even after incorporation and product development (ex: I’m 4 months into the business)

Yes. We’ve also updated the Founder’s Agreement to include a start date for each Founder, allowing you to pre-determine when they will start with the Company.

How do people build in variability in regards to the value of their equity stake? How can you assess value of work and then adjust equity %’s accordingly?

To learn more about this please see the following blog article:

https://blog.clausehound.com/tips-and-tricks-how-to-compensate-a-new-team-member-in-equity/

Can you force someone to sell their shares at cost if they leave after a cliff?

The company may reserve a right to buy back fully vested shares.  Employees may decide not to work for a company if the scheme is too harsh.  Considerations will include (1) what the price per share will be at the time of buy back, and what the time period is for the company to repurchase.  Companies may take the stance that the growing company has issued shares for the purpose of working together to achieve a common goal of selling the business or reaching sustainability, and until the company gets to the point of sustainability, the shares need to be reserved for the employees who are still “in the trenches.”

Does a vesting period have an implied cliff or is it pro-rated? Example: If someone gets 25% of their share over 4 years with a 1 year cliff, my understanding is that: After 1 year they immediately get 25% 6 months into the second year, they have 37.5% (pro-rated)…..is that correct

Yes, looking at the language of this clause, that looks right. You could also could add that after 6 months the employee would get nothing.