166: Fired: The Inside Track on Professional Prenuptial Agreements

ABOUT THIS EPISODE

Contact info:

Jotham Stein

Email: jothamstein@jotham.com

Phone: (650) 327-1900

Website:http://www.jotham.com/

LinkedIn: https://www.linkedin.com/in/jotham-s-stein-7b92474/

Book website: NegotiateLikeaCEO.net

Bio:

Jotham S. Stein is the principal of the Law Offices of Jotham S. Stein P.C. He has more than twenty-five years of experience representing entrepreneurs, C-Suite executives, board members, venture capitalists, private equity principals, investment bankers as well as employees of companies of all types and sizes. Stein is also the author of Executive Employment Law: Protecting Executives, Entrepreneurs and Employees, a how-to guide for practitioners. Stein’s new book, Negotiate Like a CEO, is an engaging look at how all employees can protect themselves with lessons learned from top entrepreneurs and executives and how you can too.

This is profit from the inside with Joel Block insights to give your business the inside track. And now here's your host, Joel Block. How often do you worry that your company, maybe you're the company founder or senior executive, that your company may turn on you after you've been there for a long time and the board of Directors or other management members decide that you're no longer a good fit? This could happen at any moment and leave you out in the cold. How do you prepare for this and how do you plan to protect yourself so you don't suffer the consequences? Stands in that question, Jonathan Stein Jotham, welcome to the show. Thanks for having me and your show, Joel. Appreciate it. This has got to be every executive's nightmare, the idea of they found a company, they stay with a company for a long time, whatever the situation, and then something happens, the wind changes directions and they get pushed out for some reason. How often do you see this? And for by the way, your lawyer, just just for disclosure so that everybody knows, how often in your practice do you see this happen? All the time, almost every day we get calls ah very often from entrepreneurs, from executives, saying I had no notice, I'm being forced out or I'm they just told me with no notice on a Friday I'm being fired. And this happens all the time, which is why we have a lot of repeat clients. At my firm practice in Silicon Valley. We also have office as in Chicago and New York. That's requitely wet against. Are you saying the same guys go for one company the next. They keep getting fired a company after company. Is that I say? I'm saying they get they I'm saying they leave one company or another and they come to us for their employment agreements or what we call a professional pre nuptial agreement, to protect themselves so...

...it never happens again. So you asked me how many times people get executives or entrepreneurs get forced out of their own companies, get fired with no notice, lose out on stock and stock options, profits, interest, whatever it is. It happens all the time. So once that you know it's the old old adage. For me one shame on you. For me twice, shame on me. Our clients don't want to be fooled the second time. So they come to US repeatedly. Now you know this Silicon Valley, certain Ames of Chicago, New York other areas. There's a lot of mobility between executives that might be at a place for six years, seven years, for years. If they're entrepreneurial, though, they'll start one company and then they'll leave after four years, hopefully after an exit, and start another one. That's what I mean by coming back to me. They were in Cincinnati, we might not have so many repeat clients because there isn't as much more ability there. So you'd so. So most of these guys are smart. They they get burned once, but they don't get burned the second time because they do it right this and have they do it right by coming to us, because that's what we do. You know, that's what said in to my book. Negotiate like a CEO. It's how to protect yourself in employment or, if you're entrepreneur, how to protect a self with respect to investors so you don't get put out on the street. Or if you do get put on the street, you've got a soft landing and what are you met my protection. You know, the reason to call the book negotiated like a CEO is, because what do the shrewdest CEOS do, male or female? They negotiate their exit, their separation agreement on day one, before they even start running the company. And so the book will tell will tell you, and what our practice does is explain to all the executives, entrepreneurs, how they enter into those agreements to protect themselves if things go wrong down the road. So most of people who who listen to show mean we have a lot of CEOS. We also have public companies and we have executives from these larger companies. Does this apply to all the executives or is this really a CEO Journey?...

All the executives and actually a lot of people in mid management, even lower levels, if you have any leverage at all, any leverage at all, you can negotiate a protective or calling a professional prenuptial agreement, a good offer letter or employment agreement. Now, if you are a CSUITE officer or a midlevel manager, you're not going to get the same deal typically as the CEO, but you certainly can get and we negotiate on half of our clients or have our clients negotiate, where we're shadow counsel all the time for executives that are lower level than the CEO. Now, having said that, there are certain companies out there or certain investors out there who won't sign an employment agreement with anybody other than other than the CEO and the CFO. There are some companies out there to do that. But when those kind of when those individuals or executives going into those companies come to us, we say, okay, you have to you have to balance the risk of going to this kind of company where they won't give you any protection. These of you all the other choices out there and maybe you want to check out another choice. You know. So these companies are are typically venture back companies. Most of them are are being funded in some way. So that's not entirely the same as the audience who listens to our show. But how readily do you notice these venture capital companies are to pay somebody off to get rid of them? That happens very frequently as well. So so what I described as the professional pre nuptial agreement is on the front en. You've negotiated that protection or that deal before you go into the become an employee. What you're describing is really what I call a backend separation agreement, so the company will pay somebody to leave. This happens very frequently, but but often, frankly, it's for everybody's best interest. So we have many clients who come to us and even one of the stories in the book of the fifty nine Vignettes I wrote to underscore what I wrote, it's the question the mythical lawyer asks of the executive is,...

...why do you want to work there? You know, why do you want to work there? So in that kind of situation it's often not always in there's a way to do this the right way and the way to do it the wrong way, and you could look at the book for the Right Way. But essentially the person being forced out, the executive being forced out, the executive who the boss doesn't want anymore, even if it's a CFO and the boss is to see you, they come and ask for a separation agreement and they do it the right way and often they're there's a sigh of relief from the boss or the team that doesn't want them in there anymore and they rush to give them a separation agreement that gives them a soft landing, even if they haven't negotiated that in the beginning, so that that happens all the time, day in and day out across companies, doesn't matter the size, doesn't matter whether the venture back public, small, whatever it is. Now, if you're specifically question is about focusing on on paying people off because they don't want have a lawsuit. Happened to cover up sort of bad activity, if you will. That happens also all the time as well. So it was it wasn't really referring to bad activities. I was really mostly distant, referring to just honoring the agreement and paying them out and get rid of them. You know, that happens all the time. I mean it. Well, if it's negotiated up front, it's easy. person the firing happens and the the executive who's been fired has this protection that I just described and they can literally stick out their hand and say pay me what you owe me, vest me what you owe me in stock, give me what's in the contract. I think what you're doing is stupid, but you know what, this is America. It's that will state. You can fire me, I'll go get a better job and you'll pay me everything. That it's in the contract. So that happens all the time, you know, and anybody who's been through litigation knows how painful this is. So at the end of the contract you have this this prenuptial agreement, this professional prenuptional agreement, that that you did five years earlier, and and the company says, you know what, we're not honoring this agreement, we're going to tear it up and and the executive has a choice and that is to sue or reading go. Can...

...you sign different if he sues, it could take years, it could cost hundreds of thousands of dollars. So what really ends up happening? Mean what our companies playing hardball there and they're really their pull ne string. What happens most of the company is honor their contracts, especially at the executive level. So what you're describing does happen. And we have represented in litigation executives exactly like you're describing, where the company Says No, I won't honor the contract or what they really do is, I hire themselves a big law firm and they try to figure out that the words mean something else other than what they clearly mean. And in that case that what some executive walks into my office with that kind of problem or entrepreneur where the contracts clear. I typically ask them what this functional was going on here. But that does happen for purposes of renegotiation, and so you then counsel the client. Do you want to go forward and sue, do you want to walk away from this, or do you want to renegotiate when it's when it's written in a separate and an employment agreement? You're right, it could take a long time, but they're. In many states the laws pro employee when it's about wages and if it's about wages or commissions, or in some states like California, equity is considered wages if it's earned during employment. There's a big step up when the contract is clear because the risk is shifted to the company. So it depends on the context the kind of advice you give, but most of the time, my experiences, most of the time companies honor their contracts. You know it. But at the executive level, the executive cannot go to some State Board of employment, you know, for assistance. I mean they have to go through the court system and the court's not going to hear this for a long time. So they're not going to make a ruling on how soft it is. It that's not the point. We're not going to dig in in this too much. But but that does it's got to happen a lot, I would imagine. There are some dishonorable companies out there that are not nice about this, certainly, and sometimes it winds in litigation. More of often you'll...

...find that there's an there's an in, there's a in the employment agreement or offer letter, there's an arbitration clause. So many companies actually preferred not to make it public and they go to arbitration. Yeah, but you're absolutely right. It is sometimes the case with any contract, could be between companies, where company breaches the contract for the purpose of renegotiated and that does happen. But it is it is not in my experience, at least with our clients, and because we write a contracts, I don't know, but but it's a it's a small, minor aready of the circumstances that it has. So this, I mean we're talking about executive but this also applies to boards of directors, boards of Advisors. You know what kinds of advice do you give people who go onto boards of directors for companies about how they how they attach themselves in the company? So there's a couple of different kinds of advice. One is if they ask us about their for docher obligations, which we sometimes get calls about, particularly if there's something wrong at the board level. But when they're going into the company, I advise them essentially one is to make sure you do your due diligence to make sure you want to be a director of this company and what, and I ask them the devil's advocate cut type of questions. Why do you want to what do you want to be a board of Director this company? And then the other part is the contract rol. So you can enter into a contract as a director, as you know, and here again you can protect your interest because if you're if you're if you're being paid to be a director or receiving equity, meaning stock, whatever restricted stock, you can enter into a contract with the company board agreement that says you'll be protective if they suddenly get up and vote you out. So that so the boards of directors are are at will also. I mean they they're not. They're not long term contracts. It depends on what state you are in and it depends on what as a director, whether you're representing common shares, who you're representing most of the time. Well, depends. Certain...

...states a director can be removed without cause any time by whoever has the voting authority, and in other states you have to have only four cause or removal, which makes it much harder. And in that case, if you have only four cause removal at the director level, which I might say, you rarely have at the executive level. But if you have a four cause that a director will typically be there for whatever the term of the directorship is, and to know that you would have to go the buy laws. Yeah, well, what's he was an example of a board of Director story that you deal with many boards of directors. I mean, I would imagine silica value. You must see this all the time. You know what's what's an egregious thing that you've seen happen at the board level. You may not as an investor, you may not like this very much, but in my view sometimes and the the investors are so focused, the board members who represent the the investors are so focused on their own investments and limited partnerships. You know who fund who, whether their private equity or venture capital. The limited partners are so focused on that they they look out for their interests before they look out for the company's interest and that happens not infrequently, which does lead to some often tension between the others on the board and if they have management team members on the board, that can often be a conflict. So I have been in circumstances. You might find this start to believe, but I did multiple circumstances over the years, public as I got no hair on my head and I've been around a long time. But where, in a tense situation, the representative, typically a lawyer for the investor directors, would say, you're right, they have a fiducier obligation to vote in favor of let's just say, I make it this up and Ma Transaction. Let's just make I make it up something, but whatever it is, they have a finisher obligation and they're going to vote in favor of that transaction because you've raised those these issues, Jontham, and I don't want to have a problem with you, but you know what, they're going to vote their shares against the transaction. So...

...if management and the other members of the board don't get together with these investors, you're going to have a very unusual circumstance where, because there's no obligate for doucier obligation to vote your shares anyway you want, you can do whatever you want. As you know, there's a difference. So that does happen. And so you've asked me what's the most egregious thing is, and that's what I that's what I see. Now. There are lots of I have to say. I've seen other pretty bad acting on various boards, even publicly traded boards, and and but I don't want to bring up the individual things, but you sort ofly see all sorts of things that happen. Let me, let me just for clarification so that everybody understand who's list. He understands you're talking about a director could own some limited shares and they can also have some director shares as and they would get to vote. There's two different things that are voting. So one is voted one way, one would be voted another way. That's what you're talking about. How I and I confused you and I apology. Guys. Let's say that there's a board, a five board members, and let's say three of the board members are are appointed by investor groups. So whether the venture capital funds or whether their private Equity Funds, let's just use that as a hypothetical. Now the company I'm using as a hypothetical, something that's good for the company, could be entering at their contract, could be doing an Ma transaction, let's just say something like that. And and they've had independent advice, the boarders at independent advice that this is a good transaction to happen. All right, for the shareholders, for all the company shareholders. All right. So that's what you have to look out for at the board level, so that they've been advised, they have all the advice that they should do the transaction. Now, for one reason or another, the three board members of the five, they have a finucial obligation to act in the best interest of the shareholders. And and so they vote in favor of the transaction as board members with their board had on. Okay, because that's what their foreducial obligation requires them to do. But then...

...any transaction, if it's if it's an m a transaction or a financing of some sort, they may have the right in the documents to give their own approval of shareholders, all right, and they have no foreducial obligation with effect to the shares they own. They can vote those shares anyway they want. So what I'm describing here is they then turn around and vote the shares that they own against the transaction or whatever it is, and and they know that that. That's exactly what I thought I heard you said. I just wanted to clarify that for everybody else that that you know that the director can have two different kinds of votes and they can vote different ways for the same thing too. Exactly it just as management has two different hats on, right, they have the had on of the director and they have the hat on of the of the of the management team. And there, if they own shares in the you know, they have the had on of their of their equity ownership. So how going to have a job when companies are bringing on board members? How going to a job do they do in your experience, in in evaluating the conflicts, because people probably have to predisclose their conflicts of interest, in the words of their holdings, their Balanchie what are the what are they doing? What are they investing in? What are they what are they involved in? What are their causes? I don't know. Whatever their thing is, they must have some process they go through. Is that? What's that process working? You know, it's very context dependent. There are companies, particularly large companies, that are very strong processes to make sure there's no conflicts. There are other companies, and sometimes very large companies, that have no process and and and they wind up with all sorts of conflicts and tension. So I can't answer that question except to say it's really context dependent because other company and depends on the experience of the of the directors on a company as well. Yeah, well, that's it. It's probably smaller companies probably do a worst job than bigger companies. Fair enough, not necessarily, not...

...necessarily. So that would be that would that's not necessarily. I can't stay. Not necessarily. It's all right. That takes the pen. I got to. So how often, you know, do you see executives from one company asked to be board members of another company, maybe in the different industry? Otherwise, are are a lot of these senior executives getting opportunities on boards and other places? Absolutely, in fact, most of the contracts we write for a senior executive says in it, assuming the executive wants it to say this, says in it that that they have the right to be on other non competitive boards. You can't be an executive on a company and be on another company that's competitive, you know, CEO one company and on the competitor company. That would be a breach of fiduciary duty unless you actually have the entire board agree. But nobody's going to do that. But most of the agreements typically nobody's going to do that. I should say they saying you never say never, but typically most of the executive employment agreements contracts provide that the executive can be on a noncompetitive board. The company then sometimes comes back and says with only with our approval, and so that there's a negotiation between the executive and the company about whether or not approval should should be required and if it's required, you know, do they have soul authority or shouldn't urge? What the fancy words are not be unreasonably withheld the approval process. But generally you will have executives and all the way, you know, at larger companies, wellnown companies often evps or just VP's acting on somebody else's board. Happens all the time. Yeah, we're not nonprofit boards. Are there typically restrictions in the nonprofit works? A lot of us are involved in nonprofit activities. You have to read the by laws to know whether there are restrictions. Some some nonprofits, for example, restrict their directors to geographic area, to an interest area, to whatever the area is. So you have to look at...

...the the the by laws to determine whether there's any legal restrictions. Then some states may have jurisdictional legal restrictions. You can't speak to that except for the states that I work in. And then and then are that I'm licensed. Then and then. What you sometimes have it at nonprofit boards is sometimes the boards become actually quite large and unwieldy, which is something you don't see as much in the private world. And so you hold boards of fifteen, twenty people and and that can be problematic because it's hard to do good corporate governance there. So it depends on the nonprofit the experience of the nonprofit. It just like any private company. Nonprofit boards could work really well and they can be dysfunctional on the other end of the spectrum as well. Yeah, so let's talk about so. So we kind of did kind of a survey of some of the issues that come up. But what are some of the specifics that executive to be thinking about in this preduptional agreement that they sign? What are the things that they should be asking for? What are the big buttons? Number one, protection of their compensation. So salary. They should ask for separation pay and advance. That's what you know. If they get fired, should they get a year's worth of salary? Should they get six months worth of salary? And then should they get their bonus and commissions or expected bonus and commissions on separation? That's one area. The second area is to protect their equity. So what I mean by that many executives are receiving stock, restricted stock, stock options, profits interests that are vesting over time or vesting by a performance, and so if they get terminated, the executive gets terminated or entreprene gets terminated before that stock vest, they typically going to lose whatever is unvested. And so the way they protect themselves as they put an acceleration clause in their professional prenuptural agreement that says determining my employment for any reason...

...other than cause, and you strictly define cause, or if I terminate my employment for good reason and you give a broader definition for that, then you, the company, will accelerate the vesting of my shares for certain number of years or time period or performance based shares. Third, with respect to the shares, if they're getting stock options, they almost always would want, and this is what executives often miss over and over again, is a post termination exercise period, so a period of time after they're terminated that's not the typical thirty, sixty or ninety days, but is rather one year, two years, three years, four years that they have to exercise their option. So what they get fired, they don't have to just exercise right away, and that essentially turns a employ short term option into a leap long term option. The third thing they would want, the fourth thing they would want, or the third thing if, if the poster an exercise period is part of number two, but there the third thing they would want is typically Cobra protection, that is, the company pays for six months, one year, whatever it is, of health healthcare benefits going forward, and that's that typically takes the form of the company agreeing to pay the premiums for Cobra for some period of time or advancing the cost of the Cobra payments. Those are the big picture. Is Shoes now and other places other things are important. So for or for individual certain individuals, they have very important things that I just didn't describe. I don't want to leave them out. So, for example, car allowance might be very important in certain places, and so you would then want to negotiate for a year to drive your car, you know, on the company's dime, if you will. Another possibility is if there are loans out there. So many public companies that can have these kinds of loans anymore thanks to the you know, some of Congress congressional acts. But if loans are out there, you don't want your loan called. I few companies giving you a loan. You don't want it called thirty, sixty or ninety days after you've been fired. You want it called a year, two years, three...

...years down the road. So if you have, if you have that particular circumstance or other particular issues, you would want to negotiate your protection before you sign your employment agreement because it's in your employment agreement and before you begin work. Are the are the kinds of benefits that these executives get that they're looking to protect. How similar would that be for boards of directors? Depends on whether they're being paid to be a board of director whether they're just getting equity. So it would be you could enter into that kind of agreement as a board of Director. There are less common but you could also enter into an agreement on that same level before you become a director. You know it's a board director agreement. Typically they're not usually getting a salary. They're getting paid for showing up or being paid for a board MEMB board membership. But so they'd be paid as like a ninety nine typically. But you can get protection any time. It's legal. You can write a contract to protect yourself, and so I have to know more of the context, but they're not. You could certainly get that kind of agreement if you wanted to. This is very fascinating to me because it it's very sophisticated and I imagine that more sophisticated people are doing these kinds of things, but I would also imagine that many, many less sophisticated executives are not getting these kind of protections. They're not going to go into an attorney in advance. They're not, you know, being counseled to do this sort of thing, and I hope that that this show helps people, because it's certainly critical information. I want to say. You ask me what they would protect themselves. The executive would. What does that mean? And an awful letter employment agreement. There are other questions that you would have to ask depending on your circumstance. So and you might want to protect yourself against it. Are critically important, but their context dependent. So I'll use as one example. If you go into a your becoming an executive, whether it's a CEO, CFO, a VP of worldwide sales, VP of marketing, whatever, or, at a much lower level even than...

...that, a midlevel manager. If you're going into a company that has significant investment from private equity or from venture capital, you need to know what liquidation preferences are right, because if the liquidation preferences are too high, then even a big sale of the company won't result in any any money coming to you as a holder of common stock. So that's one thing you would need to know. Another question you must ask if you're going into a company like that, where you don't know public company, is no problem. You can look at the Internet and and find out what the capitalization is. If you don't know what the capitalization is, you got to ask that question as well. Now, if you show up and you're going in as an executive in a company, US an example why this context depended. If you're going to become a CEO of a company that is high liquidation preferences, well then you have to negotiate into your contract protection that the protection for your equity includes protection against the liquidation preferences, which would be something called a management carve out agree or management carve out clothes, and so let me just say that in case anyone doesn't know what that means. It means the liquidation preference. Means who gets paid first, as you're kind of winding things down and there's typically an order of who gets paid when and what and how much they get. And the bottom line is the people at the bottom get paid little or nothing. That's just kind of how or they could get a lot if there's a lot left over, but there's usually not, because people at the top tend to tend to take out quite bad so it's a tough it's tough, then, yeah, it's not an and. And your use of winding down that you mean winding down a company, but could be very positive. So, for example, just make it up. Let's just say liquidation preferences or two hundred and fifty million dollars, and and the company then sells for two hundred and fifty million dollars. Okay, everyone that holds stock or stock options the company at on the employee level, management level, any level below the level investor, will get zero from that transaction because the first two hundred and fifty million dollars...

...of this example. Are you smoking for? What's that? It's already spoken for. It's already spoken for. It's spoken but for for the investors who invested, and they typically get a higher class of stuff, cold preferred stock, and and they don't have to. Sometimes they would have invested two hundred and fifty million dollars of this example, and so they would just be getting their money back. But in other examples they've only invested fifty million dollars. If they and they have a that would be that would be sort of pig like, but that would be a quintipple participating preferred stock and they we get all the money, even though they'd only put fifty million in. So you want to be very careful and ask those questions. That's what I mean. I gave the broad based answer for what an executive would want and their employment agreement, but every buddy situation is specific and you have to know what the you have to know the questions to ask. So so you learn how to protect yourself. Yeah, if you know, I'll tell you. If that question doesn't tell somebody that they need the help of a professional person. There is no other example because because that just isn't something that somebody walking down the street doing their regular business would think of if you haven't been down the path and understand how preferences work, how liquidation works, how you know and and liquidation doesn't mean wind down enclosed business. It could be a sale, it could be a good public and it couldn't be anything. And they could be anything where money moves into transaction. Right. So you know, if that, if that doesn't tell you, I don't know who, I don't know what would. So I there's one of the fifty nine stories in my book. Negotiate like a CEO is just about that and it's about I have had the shrewdest clients who don't understand liquidation preface. As an example or what you really need to do, look at in a cap table. So there's a story, one of the fifty stories in the book is exactly an off. First come in. These are mythical characters that it's interesting the story. The banker says we have an offer. The mythical banker says we have an offer for your company for a two hundred million, two and fifty million, and there the CEO is screaming, be know across the zoom we're not doing this...

...deal. And it's two executives are sitting in the room with them, senior executives, one of whom doesn't understand and didn't know anything about liquidation preferences and is multiplying his equity ownership in the company by let's say two hundred million, so he owned five percent of the company. He thinks he's going to get ten million dollars. And only after the fight happens and the mythical CEO tells screams at the mythical banker and says don't call me back unless you got me a better deal. Does it does one of the executive who understands explains to a very senior sea suite level, mythical executive director, you understand, you're not getting any money if we sell this company for two hundred million and you're not going to be able to bite that house and that boat that you're planning use. You're getting nothing. And and the mythical seat, the mythical in this case evp of worldwide sales, says, what do you mean? Why did anybody tell me about this? And the and and and then they he explains. That's how you underscore the story. This. The senior executive who does understand says, what do you mean? It's all in the documents. Didn't you look at the documents? But you know, I can't tell you how many people. It's. You know what it's. It's a complicated discussion that's so overthhead of most people and that's what they need a competent council for that. That's that's you know, listen, this is I love this discussion that this is it's a little technical, but this is really this is really helpful for a lot of people. And you know, the promise of our show is the inside track, the best Mardis and fast way to get something done, and you've definitely delivered on the on the promise and kind of given us the inside track about how some of these transactions work, what to think about, where to go and when people deliver on the promise, we call those people advantaged players, and you certainly aren't advantage player and I really appreciate you being on the show. Well. Thank you very much for the compliment. I appreciate and listen. We'll put will put your contact information in there for any executives that I need you and will also put a reference to your book. You're good. That helps people negotiate these types of deals. So...

...thanks so much for being part of the show and contributing and for being an advantage player. Thank you very much for having me on your soljoal Joel, I appreciate it. You've been listening to profit from the inside with Joe Block for more insights and to learn more. Is it Joel Blockcom? How about a shout out and a huge thanks to our podcast show producer David Wolf and the team at Auto Vida Studios. Profit from the inside wouldn't be possible without these wonderful professionals to learn more or to find out how you can launch and produce your own podcast show, reach out to www dot viacom. That's a UDI, the iacom.

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