Employment Contracts for Startups

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Canadian startups should have an employment contract for all new hires. An employment contract helps both parties understand the employment relationship, protects the startup in the event of the termination of employees and it can also serve as a useful mechanism to attract good employees.

A solid startup employment contract should contain all the usual, common-sense elements contained in an employment offer: term of employment (i.e. indefinite or some fixed term), salary, vacation, benefits, start date, the startup’s right to amend the terms with notice, etc. However, a really good employment contract, especially for startups, should contain:

  • a termination clause;
  • a probationary clause;
  • a series of restrictive covenants;
  • a warranty clause; and, if applicable
  • equity and incentive clauses.

Termination Clause

An employment contract should have an enforceable termination clause made by an employment lawyer for employers which delineates the employee’s right to notice / severance upon termination. Without a termination clause, the common law of notice / severance automatically applies, which can be expensive and unpredictable for startups.

  • Notice / severance comes in two formulas: statutory notice and common law “reasonable notice”. Statutory notice is the minimum amount of notice that an employer must provide an employee according to government law (i.e. the Employment Standards Act). Reasonable notice, on the other hand, is the amount of notice that an employer must provide an employee according to judge made “precedents”.
  • Reasonable notice is normally much more beneficial to employees than statutory notice, at the expense of employers. While the Ontario Employment Standards Act’s minimum statutory notice provisions provide only one week of notice per year of service, up to a maximum of 8 weeks, reasonable notice can provide up to a few months of notice per single year of service, up to a maximum of about 26 months.

The termination clause in the employment contract could be drafted to limit the employee to minimum notice / severance under the Employment Standards Act to just one week of notice / severance for every year of service. Or, the termination clause in the employment contract could be made by an employment lawyer to delineate some kind of formula which is more favourable to the employee (i.e. two weeks per year of service), which is relatively attractive to some candidates but still serves to somewhat protect the startup from potentially expensive common law reasonable notice.

In addition, there should be a clause under the “termination” heading stipulating what is “just cause” to terminate the employee without notice / severance (i.e. serious misconduct, theft, harassment, etc.).

Finally, there should be a clause informing the employee of their obligation to provide some reasonable amount of notice of resignation. A small startup could be ruined if their employees were to suddenly leave without any warning.

Probation Clause

An employment contract for a startup should contain an enforceable probation clause made by an employment lawyer. That way, if someone doesn’t work out right off the bat, the startup can terminate that person without giving any notice / severance, saving a lot of money.

Restrictive Covenants

An employment contract for a startup should most certainly contain enforceable restrictive covenants made by an employment lawyer. Restrictive covenants are clauses in employment contracts that prohibit an employee from doing certain things during and after employment.

Startups need to be especially cautious of employees competing against them, stealing their clients / employees, claiming inventions as their own or using the startup’s trade secrets to advance their own projects.  Thus, these key restrictive covenants, which should be crafted by an employment lawyer, should be included in startup employment contracts:

  • non-competition clause, which prohibits employees from competing with their employer for a set period of time after the employee leaves the employer;
  • non-solicitation clause, which prohibits employees from soliciting or dealing with customers of the employer. Non-solicitation usually also prohibits the employee from soliciting other employees to leave the employer;
  • An invention clause, which outs the common law presumption that an invention made while employed belongs to the employee, not the employer; and
  • A confidentiality clause, which prohibits employees from disclosing confidential information or trade secrets they acquired during their employment, which is especially important for startups in the tech sphere.

Representations / Warranty Regarding Past Employment / Inventions

An employment contract for a startup should contain language whereby the new hire agrees that they are under no restrictive covenants from past employers preventing them from working for the startup. In addition, the startup should ask the hire for a list of all their claimed or pending inventions, if applicable. That way, the employee can never later argue that they invented something before or during employment with the startup that they should be compensated for by the startup later down the road.

Equity Offering

In addition to protecting the startup, a good employment contract can serve to actually attract top talent. For example, a well written equity clause, which has favourable terms for the employee, and is set out in a clear manner, so the employee feels his or her investment will be protected, can serve to push the startup above others in securing key employees in a competitive market.

If there are share / equity agreements with founders / investors already in place, startups can attract the best talent by offering potential hires a piece of the pie. In this regard, an employment lawyer can draft in the employment contract a promise to pay equity, often in the form of phantom stock agreements, options or restricted stock unit (RSUs) grants after some kind of cliff / vesting period.

However, the startup should be cautious to word this promise of equity properly, especially in case of early termination. The employment contract, if it offers equity, should therefore insert into the termination clause (as discussed above) that vesting stops after the statutory minimum notice period.

Incentive Income

Smart startups pay their employees a bonus for hitting certain targets. This is because most other startups, especially in the tech industry, have incentive plans and that therefore, startups without a good bonus plan will be less attractive to the best candidates.

An employment contract drafted by an employment lawyer can define what the target is for bonus payment and what percentage of the bonus will be paid based on achieving a portion or more of that target.

In addition, a good bonus plan can save the startup a lot of money in case of termination. If an employee’s normal annual income is 50% salary and 50% bonus, then the employer would only have to pay the salary portion of the employee’s income in lieu of notice / severance at termination, beyond the statutory minimum notice period, if the termination clause (discussed above) says so. But, like all of the above-noted recommendations, consult a lawyer to create this clause to ensure you are drafting it in a clear, concise and valid format.

Dutton Employment Law’s employment lawyers are sought after by many startups to draft employment contracts.

Dutton Employment Law also reviews employment contracts for employees of startups.

Please contact us if you have any questions.