NEGOTIATING EMPLOYMENT CONTRACTS
Below is an article by Robert Adelson that was first published in the 1998 GEN Guide to Biotechnology Companies, published by Genetic Engineering News, dealing with the key compensation, equity, and employment terms C-Level, senior executives and other key employees should seek in negotiating employment contracts. Although the article was originally directed to executives with biotechnology and life science companies since that is the target readership of the publication, the issues discussed are relevant for C-Level and senior executives in other technology and non-technology based industries.
Negotiating Terms of Biotechnology Executive Employment
By Robert Adelson
Without properly navigating the employment contract, a biotechnology or life science industry executive can lose large sums of money or limit his/her career. Skills and experience valuable to a company deserve proper employment and compensation terms.Similarly, a company without financial means to recruit top talent needs to know other ways to reel in the prized hire. The employment contract can be used as a recruitment tool without trading the company for an executive.Oftentimes, biotech CEOs and other senior executives are great negotiators for strategic alliances, but they neglect negotiating terms of executive employment.
The best time to negotiate employment terms, including compensation, relocation, tax gross-ups, stock and options is before an offer is made or accepted. Below are ten critical areas that executives and companies should both consider negotiable to assure that both are treated fairly.
1) Signing Bonus
The provision of a signing bonus accounts for risks taken by the new executive such as vesting options, bonus or other benefits that may be lost in switching jobs. The bonus demonstrates a joint commitment and cements the legal/psychological bond between a potential recruit and company. Furthermore, it compensates for both known and unforeseeable risks that may arise.
What a company pays up front can vary, depending on need and perceived immediate value received by the company. Bonuses often include 15-25% of annual cash pay, 20-35% vesting of options, below-market stock or a retirement annuity and other considerations and combinations.
2) Meaningful Equity
To reward the executive for both company and individual achievements, the new hire should gain a real stock stake. The company should structure stock or options comparable to industry standards. The offer can be further enhanced with a package of rights that can include anti-dilution, registration, and cash-out protections, vesting and change of control protections, extended exercise of options on employment termination. Meaningful equity should be sought by the executive in advance, but sometimes packages are developed and approved by both sides over time.
3) Tax-favored Equity
To leverage future payout, the company should structure equity taxed as low as possible and boost executives’ take-home pay. Here, the rule of thumb is: options are the best for high-value equity: stock is best for low-value equity. According to current federal tax laws, the best equity arrangement for both the executive and company is to maximize the executive’s potential use of the 50% or greater deduction for ordinary capital gains and, where possible, even larger deductions or even no taxation for certain long-term gains in smaller biotech and medical device companies, when those opportunities are presented by Federal tax law. Tax advice needs to assure the right mix of equity, including stock, ISOs, non-quals, SARs, or Phantom Stock arrangements. Each must be carefully structured to avoid ruinous “tax surprises” down the road.
4) Relocation Assistance
The company should assist the new hire by covering the cost of relocation. This includes out-of-pocket cash expenses of temporary living, storage, moving, dual mortgages and losses on home sale and costs of purchase. Companies can write contracts that avoid taxable income for the executive or that allow for tax gross-up, as needed. Increasing use of temporary living arrangements can benefit both executives and companies by allowing each to develop their relationship before the larger commitment by the company and executive becomes a permanent relocation.
5) Position, Duties, Support
To keep current and familiar in the industry, the executive needs to assure his authority and have visibility. For the interest of both parties, confirm officer and/or board positions, expected responsibilities, known performance targets, organizational authority and reporting structures right away. These duties and targets can be adjusted later, as needed. Company and executive should also discuss staff, facilities and budgets, and D&O insurance. As long as outside board and advisory positions do not present a conflict of interest, the company ought to allow these to the executive.
6) Expense Payments
Investing in the executive’s education and advancement can benefit the company as well by making the hire more valuable. In addition to reimbursement of business travel and normal job-related expenses, executives should assure company support to maintain M.D. and other professional credentials and memberships before signing an employment contract. Companies should also underwrite executive initiatives that will allow him/her to remain current, visible and connected in the field. These include time and support for speaking and attendance at national meetings, symposia and continuing education programs.
7) Non-competes and NDAs
Companies must protect their existing and future trade secrets through non-disclosure agreements (NDA), but the NDAs should not reach into prior knowledge and publications and information generally known in the field. “Non-compete” agreements should be separately calibrated for three concerns: the executive taking a position with a competing firm; soliciting customers, prospects, grants or partners; or raiding employees after having moved on to a new position in another company. The period should be measured by expected shelf-life of confidential information and time needed for the company to reestablish itself and integrate a successor executive into the prior relationships involved.
8) Term and Termination
It’s better to provide for the unexpected when it comes to term of employment. Companies should provide a fixed term contract and mutual early termination clauses, with and without cause. That way the executive and company enter a relationship knowing the rules that will guide you when and if change occurs in the future. With-cause termination clauses should be based on matters under the offending party’s control. Without-cause termination should require each party to provide a notice and concede with-cause contract rights.
Severance protects against the company’s normal right to terminate without cause and against the executive violating non-compete clauses on termination. These vary by position, six-month to one-year severance being common, often phased on period of service with the corporation. This ballast, along with binding arbitration, English rule on attorney’s fees, and similar contract enforcement terms, strengthens the confidence that the contract will be followed.
10) Personal Fit Still Counts
A well-planned employment contract paves the way for a successful executive/company relationship. However, compatibility with company and fit of skills and personality, as well your own intelligence information on the company’s current business status and potential, are key to the success of the partnership. The company’s conduct in negotiating terms of employment can offer you valuable insight into the company’s decision-making process, motivations and flexibility, as well as your potential fit. Never fear the word “no” in negotiations. Avoid a job if your negotiations reveal traits that warn of a bad fit. A good contract does not make a good job. There is still no substitute for doing homework by each side on the other. But, by thoughtfully negotiating these “Top Ten” areas, both will learn insights into what the other is about. The resulting contract will reflect the above-board style and approach of both parties and lay a foundation conducive to getting the best from both sides.
Robert A. Adelson, J.D., LLM is corporate and tax attorney and partner at Engel & Schultz LLP, Boston, Massachusetts. executiveemploymentattorney.com He represents C-Level executives and key employees in biotechnology and life science companies in negotiations over employment terms, retention, equity, relocation and separation. Mr. Adelson also represents C-Level executives and key employees in such negotiations in other thecnology and non-technology based industries.