Employment Contracts . . . 

are agreements between a company and its employees that set forth the terms of their tenure. They are used for a variety of purposes, including attracting key people to join a company by guaranteeing their salary or describing their benefits. They can also be used to define job duties or to bind an employee to secrecy and non-competition agreements. Employment contracts can provide protections against arbitrary firings. If properly written, they can even help companies avoid expensive fights over trade secret infringement claims made by former employers of newly hired company personnel.

Employment contracts with key employees are important to many investors. Young companies usually depend more on the talents of a small group of people than do their larger, more established competitors. Because of this, most investors require assurances that a company’s key people will remain after funding. They want to know that the people they evaluated will stay around to run the company with their money. At the same time, entrepreneurs often want protection against being fired when new investors are brought in. It is no surprise, then, that an important negotiation in many venture financings deals with who will enter into employment contracts and what the terms of those contracts will be.

Employment contracts do not always make sense for a company, however. As a general rule, employment contracts should be avoided unless they serve a specific company purpose. Giving an employee a contract that guarantees his employment for a period of time does not further company interests unless it is necessary to secure an important benefit for the company, such as convincing the employee to take the job. Because of the personal-service nature of employment, employment contracts are usually ineffective at forcing an employee to stay with a company. They are even less effective at keeping an employee interested in doing a good job. At the same time, however, employment contracts can cause management to retain an employee longer than it wants or to pay a departing employee a premium to leave.

Investor preferences for contracts with management do not mean they like rich employment contracts. They expect entrepreneurs to sacrifice present earnings for the prospects of long term capital appreciation. Managements that crave large salaries and elaborate executive benefits can scare away venture capitalists. Contracts that insure management employment for too long or in circumstances that could jeopardize a shareholder’s investment also cool investor enthusiasm.

Venture investors want the freedom to remove management if it proves to be ineffective. At the same time, managements want some security against arbitrary firings. Employment contracts are designed to reconcile these different points of view. See: Compensation and Bonus Plans, Confidentiality Agreements, Golden Handcuffs, Noncompete Agreements, Vesting Schedules.