Considerations to retain an employee Flashcards
Three year agreement , Restraint of trade, Share option
What does a three-year service agreement mean? Does it mean that the agreement terminates
after three years and the parties need to renegotiate a new contract? It may be better for Matty to
have an employment contract that continues until he resigns or is legally terminated by DMG.
What are Matty’s future plans? He might not want to be locked in for three more years, e.g. if his
health is failing or he is close to retirement.
Alt. The three year agreement will provide him with
additional job security
The three-year restraint of trade proposal would potentially be unacceptable to Matty – Matty
receives no compensation for effectively agreeing not to work for three years at a competitor.
There should be some form of compensation.
Matty could, however, view that receiving share options is adequate compensation for the restraint
of trade should he intend staying on for at least three years
Current budgeted production for FY2019 is 40 000 bottles (i.e. 120 000 bottles over the three
years) before considering the YupD and the miniature bottle opportunities. Is the 200 000 target
realistic?
As an alternative to the propsed agreement, Matty could explore the possibility of him patenting
the recipe and thereby earn royalties on the use of the patent.
Matty should consider what the shares might be worth in three years’ time (especially given the
company’s proprietary status). Potential dilution of shareholding if share options given to others
Having production targets as a KPI could be counter-productive for all parties. It is likely that Matty
will not have control over production volumes as this is likely to be driven by sales demand. Matty
should consider suggesting alternative KPI’s such as product quality, awards, new products,
customer recruitment etc. Production targets should rather be driven by customer demand and
realistic market share. If there is limited demand for the product, then manufacturing operations
would need to be scaled back
The income tax considerations for Matty associated with the share option needs to be considered.
The section 8C gain will be taxed upon vesting of the shares
The opportunity to own 10% of DMG could be enticing, but shares in a private company are
generally illiquid. It is difficult to sell these due to pre-emptive provisions.
Company perspective
Company perspective
While a three-year service agreement may suit DMG, if Matty is critical to the business then an
ongoing contract would be preferable.
A three-year restraint would protect DMG in the event of Matty leaving the employ of the company,
however the restraint of trade only applies to South Africa and Matty could go to another country
such as Mauritius
The enforceability of restraint of trade agreements is a complex area of law and DMG should
therefore ensure that they seek legal advice when drawing up this agreement
Production volumes may not be the most appropriate KPI. Surely, the KPIs should focus on what
Matty can control and contribute, and aim to maximise earnings for both parties. Targets could
possibly be extended to include other non-financial measures such production efficiency, meeting
costing benchmarks, market share, customer r satisfaction, awards, etc.); alignment with strategy
(such as a number of flavour variants, innovations)
Product quality should also be key and therefore incorporating the KPI relating to product quality
as suggested will protect DMG
Matty may feel more attached to DMG if he has share options. He may behave more like an
‘owner’ given the potential sharing in future dividends and sale of shares, which would be to the
benefit to DMG. This will assist with ensuring goal congruency between Matty and DMG.
The employment contract / restraint of trade should incorporate additional specifications such that
the unique gin recipe belongs to DMG and that Matty is prohibited from using it after his contract
with DMG expires and that Matty is prohibited from using DMG’s customers contact details after
he has left DMG.
DMG needs to have a succession plan in place in any even
Share options are not tax deductible for DMG, whereas payments for restraints and bonuses
would be
Share options would dilute existing shareholders’ interests.
Matty’s skills are essential to DMG’s success – the company should almost be willing to pay Matty
whatever he asks.
