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How to craft an employment contract that gives you the best deal.
Marie Leone, CFO Magazine
November 1, 2008
What soft economy? With your talent and track record, plenty of employers would jump at the chance to sign you up. That's the frame of mind you should put yourself in when you're negotiating a new employment contract. Having that leverage will help you pinpoint — and build on — the provisions that matter most.
Executive employment contracts are typically 10 to 20 pages long, and are saturated with subtleties that any careful candidate needs to know about.
Not that every financial executive will have a slew of decisions to consider. For some, the contract may consist of only one provision — but it is an important one: a Change in Control Agreement. This spells out the details of what will happen if a new owner appears and brands you as redundant. "CFOs are among the most expendable senior executives in an acquisition," notes Bud Robertson, CFO of $500 million Progress Software, which serves businesses. "If your employer gets acquired, you are probably gone." The Change in Control document is your severance package, so make sure it accommodates the position you'll be in. After all, as Robertson points out, getting hired anew will take some time. "You aren't just going to interview with three people at the company and get the job of CFO," he adds. When a potential employer hands over the agreement, make sure to ask: "How long after my exit will I continue to be paid?" "Will I get my base salary and my bonus?" "Are benefits included?" "Will my options vest faster?" You want all of that — and for a year (see "Expendable You" at the end of this article).
In fact, as you evaluate any contract, consider first what happens when you leave; it's important to know, and be comfortable with, the terms. Yes, it's about as romantic as a prenuptial agreement, but it must be done. Termination clauses tend to be tough to negotiate and have the potential to be real pact-smashers.
How so? Consider a recent situation that pitted a highly sought-after CEO against the hard-nosed chairman of a real-estate development firm. The two made an agreement — sealed only with a handshake — that the CEO would resign from his current post and join the developer. The coveted executive was potentially a key driver of the company's future fortunes, and he negotiated a compensation package to reflect that.
The chairman, who prided himself on being a savvy negotiator, instructed his lawyers to include a harsh termination clause as they drafted the employment contract. By the chairman's lights, the clause would serve as a bargaining chip he could use to whittle down his original lucrative offer. Among other things, the chairman had promised the future CEO a huge supplemental retirement benefit.
As a result, the contract's just causes for termination included an aggressively subjective yardstick: "Failed to meet board of directors' standards." Not surprisingly, the candidate suddenly stopped returning the chairman's calls and the deal died. The CEO considered the overly aggressive clause a show of "bad faith" by the chairman, says J. Mark Poerio, an employment practice partner at Paul, Hastings, Janofsky & Walker. "It is fine to want to protect corporate interests, but not to the point of sending signals of mistrust."
While termination clauses can be especially delicate, it's important to study other provisions as well. If you're dealing with a public company, there's a new Securities and Exchange Commission rule that requires it to disclose, in detail, the proposed compensation package. That means investors and other stakeholders will have to be placated — so don't expect to make your getaway with a parachute of gold, especially these days.
How Long, How Much
The agreement usually starts off with a definition of the period it covers — generally in the range of one to five years — followed by a clause about automatic extensions that includes the caveat, "unless the board decides otherwise before the renewal date." This is also an area that new hires often overlook, says Maria Hallas, an employment attorney with Greenberg Traurig. What at first appears to be a yearlong contract could include a provision allowing the executive to be axed with just 15 days' notice and a month's pay. Be aware, says Hallas, that what you're being offered is "really a monthlong contract that is renegotiated year-to-year."
Salary may also appear to be fairly straightforward. Nonetheless, candidates should benchmark salary and compensation packages against peer-company data to develop a sense of where their deal fits. Underpaid? Remind them, sternly, how lucky they are to have you. Overpaid? Remind yourself — under your breath, of course — how lucky you are to have snagged this new gig.
Compensation language starts with the base salary and should end with a clause about how annual increases will be calculated. Candidates should argue for as much detail as possible, says Poerio. For example, negotiate a written commitment from the board that it will develop a compensation formula by a specific date for doling out cash bonuses, stock-option grants, and restricted stock. In addition, the provision should include details about performance goals and targets that trigger the formula.
Another tip: make sure any stock-option provision goes beyond noting the grant date and number of shares that a candidate has the option to purchase. Incoming executives should ask for details about options vesting and expiration as well as the possibility of cashless exercise (a method for converting options to stock without covering the strike price). It's common for a CFO-level hire to receive restricted stock as a signing bonus. As Harry Graham, managing director at Smart Business Advisory and Consulting, a compensation and benefits firm, points out, while stock options and restricted stock are popular forms of executive compensation, some aspects of both have changed in recent years.
For instance, both types of awards now often have vesting schedules tied to performance rather than to time served, as a response to institutional investors' demands that boards encourage accountability. That is especially true for restricted stock, which must be booked at its fair-market value and could turn out to be a drag on earnings if a company is struggling financially. When stock awards appear in contracts, however, candidates should insist that vesting periods and net settlement clauses be included.
Companies are usually keen to insert "clawback protection," which enables them, under specific circumstances, to take back the goodies they have given you. Broadly, these provisions state that the executive will forfeit all or some of the stock awards and any proceeds or shares received if the employee violates the company's loyalty pact or is involved in fraud or misconduct, usually related to a financial restatement. Should you ask about clawbacks if you don't see them spelled out? Probably, even though it may prompt a somewhat naive company to investigate adding them. Otherwise, you could set yourself up for some ugly surprises, particularly if clawback details are buried in a separate stock policy agreement rather than in the main contract.
Compared with salary clauses, termination clauses contain much more nuance. The company typically inserts language about termination with "just cause" — describing the grounds for it and how the procedure works. Usually, compensation and benefit accruals cease immediately and executives forfeit any nonvested stock awards and benefits.
"Just cause" usually means serious infractions, such as an indictment or conviction on a felony involving fraud. It also can refer to any material harm done to the company or investors arising from inappropriate use of company funds or property, general misconduct that soils the company's image, intentional malfeasance, gross neglect, or impaired judgment caused by alcohol or drug abuse. Further, most executive employment contracts include a statement warning that any breach of material provisions of the contract itself constitutes just cause.
In general, the employee wants the "cause" for termination to be "as heightened and narrow as possible," advises Hallas. The description should be minimal to the extent that it avoids ambiguous definitions, such as moral turpitude. Instead, insert specifics. A contract could note, for example, that a CFO must meet certain financial goals to keep the job. Sound tough? Sure, but you don't want the just-cause standard to feel arbitrary or unfair.
New hires should also keep an eye out for clauses that relate to claims release. "It is a critical company protection," maintains Poerio, who says that if it is not included in the contract, "don't mention it." A claims release provision promises candidates a set payout *#8212; usually a multiple of salary — if they agree not to sue the company for firing them without cause. Companies often attach claims releases to the contract, and stipulate that if the law changes, it has the right to rework the agreement. "Say no," insists Poerio.The deal at the time you sign the employment contract should remain in place until the contract expires.
Pay As You Go
No executive should exit empty-handed. Executive contracts ought to contain some language guaranteeing that compensation and benefits will be paid through the agreement's expiration date if the CFO dies, becomes disabled, is dismissed without just cause, or resigns for a "good reason" — which can include a demotion, an office relocation farther than 50 miles from the current address, or a cut in salary. Further, incoming executives should argue for accelerated vesting on stock awards, although the company may need to be nudged on that issue. And then nudged some more. Severance payouts usually range between one and three times current annual compensation, or sometimes the average of those two sums.
Change of control is another event that falls under the "good reason to resign" category. The change can relate to a merger or acquisition, a significant change in board members, or an investor buying up an unusually large stake. In any case, clauses defining such change should be clearly spelled out. A private company likely will demand that its executives surrender their equity (phantom or otherwise) as they exit. That's why candidates should push for language specifying that if they have to surrender shares, their payout will be based on the fair-market value of the stock. This is also the place to indicate how the shares will be appraised — by a third party, for example.
It is also crucial to review noncompete agreements before accepting a position. These are intended to keep departing executives from working for rivals or in related industries for a period of time. But they often cannot be enforced, says Poerio. Not that you need to share that with your employer. Such restrictions purport to cover time periods from six months to two years, usually specifying that the departing executive cannot solicit the company's customers, raid the staff (even if the staff member approaches the former executive), make disparaging remarks about the company, or disclose critical information.
Department of Perks
Perks are part of every executive employment contract, but they can "be a lightning rod for criticism," says Poerio. Now that perks must be publicly disclosed under the new SEC rules, "my tendency is to forget the perks and make it up in salary," posits Poerio. He reasons that if the executive needs security protection, that's easy to explain to investors. The Mercedes-Benz not so much. Remember, fringes still have to be "critical and justifiable," but that definition can stretch pretty far — all the way to your country club of choice, in fact.
Not that you're likely to be spending much time there. That's why it's worth remembering that when you and your new employer reach an agreement, you shouldn't do so on the basis of an appealing employment contract. Don't let fancy documents blind you to the job itself. And what if you decide it's just not what you want to do? You can stop negotiating at any time and you don't have to say a word. Just drag your attorney to the next meeting. "Companies don't like that," assures Hallas. Right then and there, they may very well decide you're not a good fit. Then it's on to the next opportunity.
Marie Leone is a senior editor at CFO.
What kind of severance package will kick in if a new owner kicks you out?
Those details are hammered out in a Change of Control Agreement, which every CFO should negotiate as part of a broader employment contract or a separate pact. Among the provisions you'll want to protect yourself:
1. A year's worth of pay, including base salary, benefits, and bonuses
2. Accelerated vesting of any stock options
3. Additional compensation to cover taxes