Key Takeaways

  • A clawback clause allows employers, investors, or funds to reclaim compensation or equity already paid under certain conditions, protecting against misconduct or unmet obligations.
  • These provisions are common in employment contracts, executive compensation agreements, and private equity or venture capital partnerships.
  • For employees, clawback clauses often distinguish between “good leavers” and “bad leavers,” determining whether benefits like stock options are retained.
  • For businesses and investors, clawbacks safeguard against fraud, poor performance, or early employee departures, and help maintain financial integrity.
  • Downsides include reduced employee morale, recruitment challenges, and potential legal disputes.
  • Clawbacks are increasingly shaped by regulatory requirements, such as SEC and Dodd-Frank rules in the U.S., making them important in corporate governance.

What Is a Clawback Clause?

A clawback clause gives investors of a brand-new company a chance to reclaim money or stock options already given to a partner or employee. Clawback clauses may also be found in the limited partnership agreements of private equity or venture capital funds.

If general partners or employees of a startup have signed a contract that includes a clawback clause, they could be forced to pay back some of their salary, benefits, and options in certain situations. This type of clause can protect limited partners or investors, letting them take back payments and equity if an employee or partner doesn't meet contractual obligations.

Types of Clawback Clauses

Clawback provisions can take different forms depending on the context of the agreement:

  • Executive Compensation Clawbacks – Allow companies to recover bonuses or incentive pay if financial results were misstated or misconduct occurred.
  • Equity and Stock Option Clawbacks – Apply to employees or founders who leave a company prematurely or violate non-compete agreements.
  • Investor Clawbacks – Common in private equity or venture capital, where general partners may need to return excess profits if returns to limited partners fall short.
  • Government and Regulatory Clawbacks – Enforced under laws such as the Sarbanes-Oxley Act or Dodd-Frank Act, requiring executives to repay bonuses tied to inaccurate financial reporting.

These distinctions highlight how a clawback clause adapts to protect different parties—employers, investors, or regulators.

Why Is a Clawback Clause Important for Employees?

A clawback clause can have a huge impact on employees in a startup. Shareholders and investors must find capable technical and non-technical people to work for them. This can be difficult because working for a brand new company has some drawbacks:

  • Crazy work schedules and demands, especially early on
  • A lower salary or less steady paycheck
  • Risk that the company will fail

Startups can offset these negatives with the promise of a payoff later. For instance, startup employees may receive equity, stock options, or other benefits to make up for lower salaries. These benefits will be outlined in the clawback clause.

If you sign a contract with a clawback clause, companies and investors can seek a vested equity if you quit or if they fire you for due cause. This encourages employees to stick with the startup instead of leaving as soon as a better offer comes along.

In European countries, clawback clauses are fairly typical, especially in startups. They are often known as a good leaver/bad leaver clause, which determines the employee's rights based on their reasons for leaving the company.

"Good" leavers stop working due to one of the following:

  • Death
  • Disability
  • Unfair dismissal

They receive their stock options and any benefits listed in the clawback clause.

"Bad" leavers include those who:

  • Breach their contract
  • Experience legal termination
  • Quit of own accord

These leavers do not receive the full amount listed in the clawback clause.

Before signing a contract with a clawback clause, employees should make sure there is a good leaver/bad leaver clause. That way, although you risk losing some benefits if you leave of your own free will, you get to keep your perks if the company decides it doesn't need you anymore.

Investors also have clawbacks. There are times when venture capitalists can take millions of dollars in interest income before their fund has repaid initial investors. Before the investors can do that, they must agree to a clawback. This gives money back if the rest of the portfolio fails or the gains are non-existent. Similarly, some public company executives must give back their bonuses if they have participated in the fraud.

Clawback Clauses in Executive Agreements

High-level executives are often subject to clawback provisions due to their influence on a company’s performance. If an executive’s compensation is tied to financial metrics later found to be incorrect, the company may require repayment of bonuses, equity, or severance packages. Regulatory agencies have strengthened these requirements in the wake of corporate scandals, ensuring accountability at the top levels of management.

Why Is a Clawback Clause Important for Businesses and Investors?

Startup companies may offer a signing bonus to attract employees. However, since they want employees who will stick with them for the long-haul, they may include a clawback clause. Then if an employee leaves early or otherwise breaks the contract, the company can get some of its money back.

On occasion, after only a year or two with a startup, employees are tempted to move on to the next opportunity and cash out. This would cut into the company's profits. Clawback clauses help protect a company's financial investment in employees. Investors may also use clawbacks in a startup to put pressure on the staff to perform well or to recoup money from file shareholders or company officers who do not meet specific goals.

Although not usually called a clawback, a company bankruptcy can offer a similar opportunity. The bankruptcy trustee, who works on behalf of creditors, can take back salaries, severance pays, and other expense reimbursements to cover the company's debt. These can even be reclaimed from employees who had nothing to do with the bankruptcy.

Legal and Regulatory Framework

Clawbacks are not just private agreements—they can also be mandated by law. In the U.S.:

  • Sarbanes-Oxley Act (2002) – Requires CEOs and CFOs to reimburse bonuses and stock profits if financial reports are restated due to misconduct.
  • Dodd-Frank Act (2010) – Expands clawback rules to cover more executives and situations, even without proven misconduct.
  • SEC Regulations – Require public companies to adopt clawback policies to recover incentive-based compensation following accounting restatements.

These rules reflect the growing role of clawbacks in corporate governance, making them a standard feature of compensation and investment contracts.

Example of a Clawback Provision for a Startup Company

A startup company hires a business manager to oversee its daily operations. The new hire signs a contract stating that if profits increase by 10 percent during a two-year period, he will receive a $50,000 bonus.

Two years pass and financial records state that the company's profits increased 13 percent, so the business manager receives the bonus he was promised. Later the company's auditors claim those numbers are incorrect and profits only increased 9 percent. Because the business manager signed a contract with a clawback clause when he started this job, he must now pay back the $50,000 bonus — even though the mistake was due to a company error.

Reasons to Consider Not Using a Clawback Clause for Companies

What investors and board members can recover from top executives might be limited if an auditor finds that the company was intentionally fixing the numbers. Because of accounting scandals over the last few decades, lawmakers have directed securities regulators to create new rules that require companies to create their own clawback policies. However, these rules have not been finalized.

The problem is that some companies have a difficult time reclaiming the money, especially from high-level employees. According to a 2016 New York Times article, the Securities and Exchange Commission (S.E.C.) has only brought 40 cases against top executives since 2011. Of the 40, only 18 have repaid their companies, and those payments have totaled a mere $17 million. Many of these cases are still being litigated.

Fast-growing technology startup companies — especially those with nonvoting shareholders — do not benefit from clawbacks. Nonvoting shareholders have little if any rights compared to voting shareholders.

Reasons to Consider Not Using a Clawback Clause for Employees

Most lawyers will tell their clients to avoid clawback clauses for the following reasons:

  • Lack of security. Promised money or stock options can be taken away after the fac, and there's nothing lawyers can do about it, especially if you have signed the contract.
  • At-will employment. If you aren't part of a union, you run the risk of investors and shareholders ending your employment at any time, even as a payout approaches. Companies can push you out before acquisition, and this move would make your stock options invalid.
  • Reduced benefits. Some companies might threaten to reclaim stock options if they feel you aren't performing well or meeting the contract terms. Even if the company fires you and provides a severance package, it might not include the stock options or other payouts you were promised.
  • Financial liability. If you've already hit your vesting numbers or cashed out your stock, you are on the hook for any clawbacks. The company will want its money back immediately, and you'll have to find a way to pay.
  • Non-compete penalties. If you signed a non-compete agreement and then leave the company to work for a competitor, make sure you check the clawback clause. Some companies write in your contract that you cannot work for a rival for several months after leaving. If you do, you could face financial penalties.
  • High risks. Since startups are unpredictable, you might not want to risk stock options and income that are based on the company's performance.

Common Challenges With Enforcing Clawbacks

While clawback clauses are powerful, they present practical challenges:

  • Legal disputes – Employees or executives may contest repayment demands, especially if terms are vague.
  • Jurisdictional differences – International companies face varying laws on whether clawbacks are enforceable.
  • Employee morale – Overly strict provisions may discourage top talent from joining or staying with the company.
  • Administration – Tracking performance metrics, departures, and clawback triggers can create compliance burdens for employers.

Frequently Asked Questions

1. Are clawback clauses enforceable in all states?

Clawback enforceability depends on state contract law and the clarity of the agreement. Courts are more likely to uphold them if the terms are specific and reasonable.

2. What triggers a clawback clause?

Typical triggers include financial restatements, employee misconduct, early resignation, or breach of non-compete agreements.

3. How do clawbacks affect executive pay?

Executives may be required to return bonuses, stock, or severance packages if performance metrics are misstated or corporate misconduct occurs.

4. Do clawback clauses apply to all employees?

Not always. They are more common for executives, founders, and key employees with equity or incentive-based pay, though some startups apply them broadly.

5. How do clawbacks protect investors?

They ensure that limited partners in private equity or venture capital funds can recover funds if general partners received disproportionate profits.

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