Starting or Joining Archives

Offered a Position and Shares in a Start-Up? – 10 Traps in the Legal Papers, and Your Ways Out

Published on March 9th, 2016 by Alan L. Sklover

“The spirit of our verbal agreement was true partnership, but
over time it morphed into this one-sided employment arrangement.”

– Actual Client Comment

ACTUAL CASE HISTORY: Kent was the Senior Editor of a major sports-related magazine. He was recruited away by a competing start-up publication, induced to leave his employer of many years by a promise of great wealth to be achieved through his becoming a minority shareholder of the new or young company. Kent gave the new magazine credibility, and for joining he was offered a large number of “Class B” interests in the company.

“When we are sold, or go public, you will become quite, quite wealthy” he was many times told by the start-up’s founder and investors. That was repeated so many times that Kent had already begun to consider where he would purchase his retirement dream, a horse farm.

Through an heroic contribution of energy, imagination, devotion, daring and perseverance, Kent helped the new magazine take significant market share away from larger, more-established competitors. He treated the new magazine as “his baby.” On a salary lower than he was used to, and minimal benefits, he built quite a powerhouse in just a few years. Sure enough, the magazine had attracted great interest, and a communications consortium came forward seeking to purchase the company that owned the magazine. For Kent, however, that was the beginning of his problems.

It all started with a casual management meeting that devolved into a discussion of Kent’s poor judgment, and then an announcement that Kent was being let go. It got worse when he learned that, because he was being let go, he would lose all of his unvested stock. Still worse, he found out that the company had a right to repurchase his vested stock for just $3,000. A third type of stock Kent had been given as a bonus had been so “diluted” by the company issuing 10 million new shares to investors that his remaining interests were worth about $45.00. Finally, he was reminded that the original documents he signed provided that Kent could now not work in the magazine industry for the next 24 months.

No job. No stock. No future. The dream had, somehow, turned into a nightmare. When Kent protested that this was not consistent with the spirit of the deal, he was simply advised, “Speak to your lawyer . . . the one who let you sign those papers.” That is when Kent called us – and not his previous lawyer – to try to salvage the situation.

More times than I can count,: someone contacts my firm and says, “I am being offered a new job. As part of the compensation package, they are offering me shares or units in the new or young company. Can you help me?” My answer is always, “Sure, I have done that many times.” A more candid answer would be “Sure, I have done that many times. However, it’s not an easy thing to do.”

“Why?” you might ask. It is not easy because lawyers for business founders or owners – particularly “Private Equity” owners, almost always make it difficult, and intentionally so. They do so in three basic ways:

First, by purposeful confusion. That is, by preparing three or four different agreements that, together, constitute one offer: (1) one that pertains to employment; (2) one that pertains to non-competition agreements, (3) one that pertains to company self-governance, itself, and (4) one that pertains to earning, vesting and possibly losing ownership interests. It’s a lot of words, a lot of pages and a lot of jargon. No single employee can understand it all. It is quite rare to find an attorney who has experience in each field. In this way, the key points – and real risks – get buried.

Second, through dreams of sugarplums. As the saying goes, “The large print giveth, and the small print taketh away.” Said a bit differently, the potential rewards are highlighted, while the likely risks are made quite difficult to spot, and even more difficult to remedy. Thus, clients begin to count their eventual wealth, which naturally blinds them.

Third, with complexity of cure. When you have three of four separate agreements, often in different typefaces, often without page numbers, always with different paragraph numbering systems and – most complex of all – with hard-to-understand, almost irrational definitions of words and phrases.

There are just too many ways, in too many different places, that the risks are effectively hidden, and the rewards are potentially forfeited. It is something akin to the game of “Whack-A-Mole,” where every time a mole appears from the ground, and you whack at him, another mole pops his head up from another mole hole.

In no other part of my practice of decades have I seen more “bait and switch” than I have in this context. The employee must make life changes and agree to restrictions NOW in return for a mere PROMISE of something to be delivered later, which “something” may in all likelihood never come to be, or if it does come to be, is perhaps 1/1000th as valuable as originally suggested.

LESSON TO LEARN: The task before us is tough: making real – at least likely – the dream opportunity, which by the legal papers has been diminished, made unlikely, and often turned into a nightmare reality by confusing, confounding and complex legal drafting. One thing the legal drafting is not is accidental. Rather it is quite intentional. That is the one thing I can guarantee you.

No matter how difficult the task at hand may be, you are so much more likely to be successful in it if you know what you are doing. Thus, by knowing the essential deal points in this context, and knowing how to address them, can only be helpful.

So long as your requests for change in the legal papers is respectfully presented, reasonable in magnitude and accompanied by a rationale – that is “I want to join you. I just need some things made clearer before I can comfortably come aboard.”

Simply signing what is before you, and hoping that you will be treated “fairly,” is not something that I have seen work out well for employees. And, too, you owe it to yourself and your family to try to avert calamity in your quest for that pot of gold. Here’s how:
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“Forming or Joining a Start-Up? – 16 Questions that Need to Be Answered”

Published on January 6th, 2016 by Alan L. Sklover

“Assumptions are the termites of relationships.”

– Henry Winkler

ACTUAL “CASE HISTORY”: Jessica, 36, was more than excited. After five years as Assistant Director of the digital division of a fashion design company, she had been approached by Martin, a colleague she knew from a previous job, about a new opportunity.

Martin was putting together a new venture that would contract out the services of tech-savvy graphic artists, visual designers, and computer coders to corporate app and website developers. Jessica saw the idea as a very good one, as she knew there was a need for such a firm from her work, and to her knowledge no one else seemed to be filling the need on a national level. More than once she had thought to herself, “Someone ought to do that.” Martin had financial backing for the venture from a hedge fund owner, and thought Jessica would be the very best person to help him put together and run the start-up.

What most intrigued Jessica was the opportunity to be a part owner of the new company, something she had often thought about but that had never before come her way. As Martin presented the idea, Jessica would have the opportunity to earn over time up to twenty percent (20%) ownership of the new company.

After discussing it with her husband, and meeting with Martin and the start-up’s financial backer, Jessica decided to “take the plunge.” She was presented with a set of papers that seemed quite simple. She was told that “formal documents” would later be prepared. In the meantime, Martin assured her, they would get things rolling and attend to the “details” later.

After leasing a small office space, hiring office staff and assembling an initial sales team, Jessica and Martin were ready to roll. As anticipated, Martin would be in charge of sales, and Jessica would be in charge of administration. Soon after, the difficulties began.

Martin expected to receive a much higher salary than Jessica would receive; Jessica presumed they would be equal. By happenstance, Jessica learned that Martin would be receiving a forty percent ownership stake, double her own, which did not sit right with her; she presumed they were to be equal partners. The company’s accountant was a cousin of Martin’s, and seemed to answer Martin’s questions, but was always unavailable to answer Jessica’s.

One of the documents that Jessica was given to sign contained a non-compete provision that provided she could not work in this industry for a full year if she was ever to leave, or be asked to leave. Jessica was truly shocked to learn that Martin remained employed by his former employer as a consultant, and so was not devoting full time efforts to this company. Each week seemed to present Jessica with another reason to question the wisdom of her decision to join.

After seven months, Jessica “threw in the towel.” She retained our firm to help her achieve fair separation terms, which proved to be more complicated than expected, and even grew adversarial over time. It was especially difficult to get Jessica’s name removed as a guarantor of the office lease obligations. To make a long story short, Jessica was happy to end the dream, which for her had become something of a nightmare.

LESSON TO LEARN: Forming or joining a start-up company is almost always exciting and exhilarating, but can also be quite disappointing. Creating a new business is difficult, but doing so with others requires more communication, focus, attention to detail and patience than most people imagine. It’s just so easy to get caught up in the enthusiasm.

It’s hard to apply cold reason to hot passion, but it is an exercise in discipline that is highly recommended, especially by those who did not do so, and sure wish they did. Here are the 16 questions I suggest you try to answer if you decide to form or join a start-up.

Every business has its ups and downs, but start-ups have them more commonly and more intensely than established firms. These 16 questions are geared to prospective founders and partners of start-ups, but are also applicable to “early stage” employees, hired after the start-up has gotten going, especially if they are told one day they might become owners by vesting in shares.

WHAT YOU CAN DO: Whether you are forming a start-up with one or two others, or being hired by a start-up, with a suggestion that one day you may become one of the shareholders, you need to ask these questions to understand what you are getting into.
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“Becoming a Consultant? – Here are 21 Smart Points to Raise”

Published on May 19th, 2015 by Alan L. Sklover

“The second mouse gets the cheese.”

– Terry Pratchett

ACTUAL “CASE HISTORY: These days, as employers are seeking to limit employee-related expenses, yet retain the services of valuable individuals, they are increasingly turning to the hiring of individuals not as employees, but as independent consultants.

The reduction in employee headcount provides employers with lower overall expense, especially as to benefits and legally-required payments, such as mandated contributions to healthcare under the Affordable Care Act, Social Security, unemployment benefits, and workers’ compensation plans. In addition, most of the many other laws that protect employees from discrimination, retaliation, harassment and non-payment of wages, are not applicable to independent consultants.

For this reason, we are seeing more and more people “selling their services” as consultants rather than as employees. The most common scenario is for a company to provide to a consultant its “standard form” of consultant agreement for signature. And just as commonly, important points in those “standard forms” are slanted heavily in favor of the interests of the company, and not the consultant.

But, “forewarned is forearmed.” You have every right, and an obligation to yourself and your loved ones, too, to request changes in the language and terms of any agreement. Here are the most important points to raise if it is a Consulting Services Agreement.

LESSON TO LEARN: Most employees do not have written contracts, for many different reasons, chief among them that employers commonly view written agreements as commitment they don’t want to make, and may be difficult to get out of. (That said, senior executives do commonly have written employment agreements that do protect them.)

On the other hand, most consultants do have written contracts, provided by the company, that lean heavily toward the protection of the rights and interests of the company. As a consultant, you look to your own resources – and not legal protections – to protect you and what should be yours. If you do not, you have only yourself to blame.

WHAT YOU CAN DO: In any Consulting Services Agreement submitted to you for your review and signature, look to see if these “21 Smart Points” are already provided and are clear, and in your interests. If not, consider asking that they be inserted to clarify and modify the consulting services agreement, either (a) incorporated into the main agreement given to you, or (b) set forth on a “Rider,” “Addendum” or “Amendment” in each instance to be signed by both sides when the main agreement is also signed.
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“How can I negotiate more equity in a start-up venture?”

Published on June 30th, 2011 by Alan L Sklover

Question: My current employer has offered me a 10% ownership interest of a new business. The new business has just the two of us: the owner and myself. I had the idea for the original product, and I am working on building the product and business, including legal, administrative and operations matters.

My employer said that, if I did not like the deal, I would be fired. How’s that for leverage! 

The new venture has $0 capital currently but he has assigned the company a value of $10 million. I feel as though I am building the ship he will sail away in.

Any suggestions regarding how I might negotiate a larger interest in the company would be greatly appreciated.

Bob C.
Boston, Massachusetts

                                           
Answer: Dear Bob:

It’s not an easy situation you’re in, but there are things you can do:     

1. The key to getting what you want from your boss is always “What is most important to your boss.” That is the number one “secret” to workplace negotiating, and the negotiating “secret” that most people fail to keep in mind. What “motivates” others is not what you want but, rather, what they want. If you can offer to help them get it, or on the other side of the coin, create some “risk” to their getting it, that will give you leverage. Keep that foremost in your mind, although you should, of course, not forget what it is you are seeking, too.  

2. It seems to me that your boss very much wants commercial development of the new product you conceived of. From what you have described, your boss thinks the new product is potentially very valuable, and he has high hopes of making it into the centerpiece of the new company – with your help. There are two things he needs to do that: (1) you, and (2) your help. From your perspective, you can stay, you can go, you can help him get what he wants, you might even hinder his getting what he wants. It will be his perception of your ability to help, or hurt, his commercial development of the new product that’s key to your request for further equity. Even the suggestion that, “You know, I do want to stay, but I would be far more motivated to stay, and work on the weekends, if I was at least a 34% partner” might be persuasive.

3. Understand that in most states owning less than 1/3 of a small company gives you essentially no rights of ownership. It’s a little complicated to explain, but the law in most states says that, in a “closely held” company, which is what you and your boss envision, ownership of less than 34% gives you essentially no legal rights, unless you have a very well-considered and carefully negotiated agreement. So, for example, if the new company decides to sell the new product to your boss’s wife for $10.00, you really have no say to block that. I often tell my clients that, in closely held companies, I would rather you be an employee than a 10% owner. You actually have more rights and say as an employee than as a 10% partner. This may be the basis for a request for additional equity: you’ve been advised that 10% means little, if anything, and may even constitute a step backward from being an employee.

4. My experience and intuition tells me he wants you to sign a document that gives him (or his company) full rights to the product. I think you may have legally enforceable rights in the idea, or the product, or you can bring the idea or product to someone else who might give you a better deal. My very first concern is that your boss will offer you 10% of the company, and have you sign a document that includes this concept: “I, Bob, acknowledge that the Product belongs exclusively to the company, and not me.” To my mind, that would be a kind of neat trick by which he gives you nothing, and takes everything from you. That said, this too might be a basis for a request for more equity: you have been told  that you may have certain rights in the product, and to give them up would necessitate more equity. 

We offer Two Model Letters you can use to obtain Rights to Your Creation at Work. For more info, just [click here].

5. My experience and intuition also tells me he wants you – and needs you – to develop the product, and after that he will find a way of “firing” you. Many people think that an employee can be fired, but you can’t “fire” a partner. Actually, it’s easier to “fire” a partner than it is to fire an employee. If that happens, after you’ve devoted years to the company, what you fear will, in fact, happen: you will “build the ship, and he will sail away in it.” You might suggest an agreement that gives you “sweat equity,” that is either (a) 5% more of the company every year, until you hit 49%, or (b) 2% more of the company each time revenues go up $50,000 (or some other number.)

You might also ask for a provision that says, “If the Company ever wants to sell the Product, or an interest in the Product, I have a right to buy the Product or the interest in the Product, for the same price offered by someone else.”

6. You might also present what we call a “trigger of value” to your boss. In this context, that would mean something like this: “If the company achieves an agreed  significant goal, say, sales of $500,000 in one year, I would like my goal of 25% ownership to be achieved, too. ”

7. I am also concerned that his “old” company is retaining rights to the product, and the “new” company you will own 10% of will not own the product. This kind of fraud happens a lot to unsuspecting employees in your situation. If you do proceed with the new company – no matter what percentage of ownership you have – make sure the product is part of it.     

8. Though you have the threat of being fired if you don’t accept the “deal,” I suggest you consider telling your boss that you would prefer either a 34% interest, or to be named a “co-owner” of the product, itself. Though this might cause your firing, in some ways I’d rather you lost your job now than have you build a product and a company, and then lose it all later. I acknowledge that it is easy for me to suggest that, because it is not me who might lose my job: this is your life, and your risk.  But I do suggest the “10%-or-be-fired” ultimatum you face calls for this kind of gutsy response.

9. If you’re not ready for this kind of risk, that is, being fired and having a bit of a battle on your hands, perhaps you are not really ready to be in business. Please don’t take this as any kind of criticism, but to be in business does require a certain level of assertiveness, risk-taking and self-confidence that is not required to be an employee. I urge you to consider both (a) do you really want the risks of being a business person, and (b) even more so, do you really want to be a partner with this person? In my experience, no one can disappoint, distract and damage you more than a partner can. You must try to choose carefully.

I’m glad to hear you are considering being a partner, and it is a very exciting step to take. Listen carefully to your intuition, don’t be afraid to be assertive, and consider, too, retaining an experience legal counselor to help guide you along the way.

If you’d like to obtain a list of experienced employment attorneys in Massachusetts, where you live [click here].

My Very Best, 
Al Sklover

© 2011 Alan L. Sklover, All Rights Reserved.

“What share should I ask for as a new firm partner?”

Published on February 5th, 2011 by Alan L Sklover

Question: I am soon to become a partner in a consulting outfit.

What should I ask to be the sharing formula as a partner in a consulting outfit that does training, development, and recruitment?

Kunle
Lagos, Nigeria

Answer: Dear Kunle, There is no one “share” or “sharing formula” that works for all service firms. Each firm is different, comprised of different people, with different contributions and different expectations. However, there are three general approaches to “sharing formulas.” In two of those three, there are five criteria used to determine shares. Let me explain:
 
a. Approach to Share Formula Number One: What I call “Equal Shares for All.” Though it may not seem like a “formula” at all, some service firms use a very egalitarian approach: all partners receive an equal amount of the profits. While I applaud those who work this way, it often leads to differences, resentments and disputes due to different work habits: some partners may work harder, some may bring in more business, and some may take a lot of vacations. Still, for the right people, this may be a great and simple way to go. 

b. Approach to Share Formula Number Two: What I call “Annual Knife Fight.” In this approach, once (or twice) each year, the partners go into a room, argue their points of view, say how they think the “pie” should be divided, agree on percentages to be used for the next 12 (or 6) months, and when they leave, shake hands . . . until the next “knife fight.” The criteria most often used by partners using this approach are explained in section “d,” below.

c. Approach to Share Formula Number Three: What I call “By Calculation.” In this approach, the partners assign a value – or points – for five (or so) different attributes that help the firm be successful. Then, each of the partners is evaluated, and assigned “points” which leads to a calculation – which can be done by a calculator – to determine his or her “share of the pie.” The criteria most often used by partners using this approach are explained in section “d,” below.

d. Criteria Used to Decide Partner Shares. There are five most common criteria used in arguing for (under the “Annual Knife Fight” approach) or in assigning points (in the “By Calculation” approach) to the partners:

1. Number of New Clients Brought into the Firm by each Partner;
2. Amount of Revenue Brought into the Firm by each Partner’s Clients;
3. How much each Partner contributes to the Administration of the Firm;
4. How much each Partner Uses the Firm’s Resources (such as staff and offices); and 
5. How long each Partner has been a Partner of the firm.

Let’s give an example, as an illustration. First, the partners would decide which of the above criteria is important to them, and assign a value to each:

a. If Partner A brought in more clients than any Partner, she might be assigned 10 points for that;
b. If her clients brought in revenues of an average amount, she might be assigned 5 more points for that;
c. If she never helped out in running the firm, she might be given 0 points for that;
d. If she used a lot of staff time, she might lose 3 points;
e. And, finally, if she was with the firm 28 years, she might get 17 points.

Her total points would be 29 points. If that was one half of Partner B’s total points, then Partner A would get only one half of the profits (or weekly draw) for the next year as Partner B received. But if Partner A’s points were 30% more than the points of Partner C, then Partner A would get a greater share of profits (or weekly draw) than Partner C.    

e. If you are the firm’s newest partner, you should ask “relatively.” By this, I mean that you should get (i) no less than any other new partner, either now or in the past,  and (ii) a sum that is higher than any other non-partner staff member. And, if you have any special talents, any special relations, any special fame, or any other special attributes, for each one you should ask for a slightly greater share of profits. Don’t be greedy – you are trying to forge a new relation with your new partners. But don’t be bashful, either. 

As you can see, there is no one best approach that fits all service firms. That said, these are the ways most service firms approach – and navigate – the task of sharing the fruits of the firm’s labors.

If you are interested in obtaining a model Partnership Agreement, [click here].

I must say that we were particularly pleased and proud to have you submit your question all the way from Nigeria. Please tell others if you have found us to be a valuable resource for your success, for which we would be most grateful.  

Thanks, again, for writing in. 

Best, Al Sklover

© 2011 Alan L. Sklover, All Rights Reserved.


Alan L. Sklover

Alan L. Sklover

Employment Attorney
and Career Strategist
for over 35 years

Job Security and Career Success now depend on knowing how to navigate and negotiate to gain the most for your skills, time and efforts. Learn the trade secrets and 'uncommon common sense' of Attorney Alan L. Sklover, the leading authority on "Negotiating for Yourself at Work™".

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