“Nah I ain’t passed the bar but I know a little bit.”
Jay Z, “99 Problems“
Let’s face it: term sheets can be complicated, but terms matter and you should understand them. The most important elements of term sheets are (i) valuation, (ii) liquidation preference, and (iii) voting. In this month’s edition of SanFranciscoVC’s Guide to Term Sheets, I’ll explain “constructive termination” and its effects.
Constructive termination usually pertains to a CEO and founders in a term sheet, but it is also found in employment letters of key employees. It means that an employee is effectively terminated without cause if one or more events are triggered, which often leads to partial or full acceleration of options, severance payments or both. One such event is if there is a diminution in an employee’s duties and title, e.g., the President is demoted to the VP of Biz Dev. This can also occur if the employee keeps a COO title, for example, but a President is hired above him/her and takes a substantial portion of the COO’s duties. Constructive termination would also kick in if the employee’s salary stayed the same, but s/he is demoted.
Additionally constructive termination can be geography-defined, e.g., the acquiring company consolidates operations 200 miles away.
The above two examples do not need to be exclusive. That is to say, a term sheet can state that constructive termination is triggered when the company moves more than x miles away, and the role of the individual is diminished.
In practice, it is “employee-friendly” to have constructive termination in a term sheet. However, some courts (especially in California) will recognize constructive termination even if it is not in the corporate docs. Conversely, if you define constructive termination in your docs in any way, courts will recognize that is has already been addressed. For example, if you define constructive termination in a term sheet by stating it is defined only if the company moves more than 500 miles away, an employee would have a hard time in court proving constructive termination if his/her role or duties are greatly reduced because s/he had a chance to address constructive termination earlier and did not.