What is a Clawback?

A clawback is a specific contractual provision. It dictates that money or equity already given to an employee or founder must be returned to the company if certain conditions are not met. While the term sounds aggressive, it acts as a standard insurance policy for the business.

In a startup environment, this concept is critical to understand before signing employment agreements or shareholder contracts. It ensures that compensation is ultimately tied to long-term performance and commitment rather than just an upfront promise.

At its core, a clawback changes ownership from absolute to conditional. When you receive a bonus or a grant of shares, the transfer of value happens immediately. However, the contract places a string on that value.

If a specific trigger event occurs within a set timeframe, the string is pulled. The individual must repay the cash or forfeit the equity.

This mechanism serves two primary functions:

• It prevents individuals from gaming the system for short-term gain.
• It preserves the resources of the company for those who remain committed to the mission.

For founders, the most common form of a clawback appears in the stock purchase agreement. This is technically known as a repurchase right, but it functions effectively as a clawback.

When you found a company, you are often issued your full stake of shares immediately. However, investors will require those shares to be subject to vesting. If you leave the company before the vesting period is over, the company has the right to claw back the unvested shares.

Usually, the company repurchases these unvested shares at the original price you paid. This is often a nominal amount. This prevents a founder from leaving six months into a venture while keeping a large percentage of the cap table. It ensures the equity remains available for the people actually doing the work.

Clawbacks are also prevalent in cash compensation. This applies heavily to sales teams and executive hires.

Consider a signing bonus. A company pays a new hire $10,000 to join. If that employee quits two months later, they have not delivered the value the bonus was intended to secure. A clawback provision requires them to repay that $10,000.

This also applies to sales commissions. If a salesperson closes a deal and gets paid a commission, but the customer cancels the contract the following week, the company has paid for revenue it never received. The company will claw back that commission payment from future earnings.

It is vital to know exactly what triggers a clawback. These triggers are defined in the fine print of your agreements.

Common triggers include:

• Voluntary termination: Leaving the company before a specific date.
• Termination for cause: Being fired for gross misconduct, fraud, or violating company policy.
• Financial restatements: This is common in public companies but can apply to startups. If financial performance was reported incorrectly, bonuses based on those numbers must be returned.
• Non-compete violations: Joining a competitor shortly after leaving may trigger a requirement to return previous compensation.

Founders must ask questions about these definitions. Ambiguity in a contract can lead to expensive disputes later.