How a startup can offer a severance package

June 14 2021

Key Takeaways

• Severance package refers to any type of payment made by an employer to an employee after their employment is terminated.
• Employers are not legally compelled to pay severance unless a contract or employee handbook specifies it.
• Severance pay may include unused vacation time as well as other perks such as health insurance and job placement aid.
• Whether or not employees are eligible for severance pay is largely determined by the nature of circumstances under which they were discharged.
• There will be no severance pay for those that are furloughed on a temporary basis.
• It's crucial to note that severance compensation is not mandated in the United States, and many employers do not provide it.
• For the startups that do provide it, one to two weeks of compensation for each year of work is typical.

Severance Definition

In the context of startups and corporations, the term ‘severance’ means 'a sum of money provided by an employer to an employee whose employment had to be terminated'.

What is a Severance Package?

A severance package is a lump sum payment made to an employee who has been discharged by the employer. It's frequently included as a portion of the severance pay, which may also contain multiple benefits like:

• Consequent medical and life insurance for a predetermined amount of time
• Compensation for unutilized vacation or medical leave(s)
• Other aspects associated with employee retirement funds and share options

Severance pay could be made either in one go (as a single sum) or in monthly instalments.

There is no law requiring startups to offer severance packages, according to the US Department of Labor.

But there’s a catch.

If an employee's agreement mentions that they will be paid a severance package if and when they are discharged from service, or if the employee handbook offers a severance package, then the startup is legally bound to honour those commitments. Furthermore, if a startup makes a verbal commitment to offer severance compensation to an employee, it must follow through on that commitment.

That’s not all...

When startups refuse to offer severance compensation, it could stir up a kind of storm among employees and create a poor public image. Sears said in 2018 that it would be laying off hourly staff with no severance package. Employees and the wider population were outraged when the business, which was bankrupt then, announced its flowery plans to grant its management millions of dollars in annual bonuses.

Employees who've been laid off, whose employment has been terminated due to downsizing, or who retire are offered severance packages by their employers. Employees who quit or are dismissed might also be eligible for severance pay. Severance pay could be a goodwill sign on the part of employers or a cushion between unemployment and employment for the employees.

What should early stage startups do?

You may offer severance pay to any and all full-time employees in your team. Because some startups are concerned about the unfavourable publicity that comes with massive layoffs, they give severance benefits to downsized employees. As an early stage startup founder, you may not be having a mass layoff, but you may choose to close down a startup unit, a particular store or a division. Paying employees one month's severance compensation (or more) will help deter potential negative coverage that local TV reporters and tabloids may generate.

Severance packages can also be used to recruit and retain employees. As part of the overall strategy to lure top talent, you could provide attractive severance packages to potential team members whom you believe would be vital contributors to your growth. While your insurance is simply a legal obligation, a severance package would provide a certain kind of confidence to an employee because you would take on some level of financial obligation in the event of termination.

Firing an employee is among the most challenging HR difficulties that an early stage startup is likely to confront. Along with dealing with the particular problem that the employee is causing, you’ll need to conduct the termination in as equitable a fashion as possible to minimize the danger of legal penalties. This necessitates planning ahead of time for a legal termination process and meticulously documenting each step as you go through it.

Severance Tax

Irrespective of whether the payment is branded "severance" or otherwise, and independent of when it is given, the IRS treats severance just like any other salary. It is susceptible to being withheld and subjected to employment taxation because it is taxed like income. If you give an employee a severance paycheck as they quit, they may anticipate it to include all of the payroll taxes they're accustomed to seeing on their normal salary.

Furthermore, severance pay is taxable under the FICA (Federal Insurance Contributions Act) according to the Supreme Court.

Severance Protocol when a Startup Employee Leaves

If you're dismissing an employee without providing them prior notice for reasons other than unethical behaviour, it's usually a good idea to presume that you ought to give severance compensation.

The following are some recommended practices to remember to ensure that the process runs successfully for all involved parties.

Review the Employment Contract

As the employer, the very first step should be to check the employee's employment contract to verify whether a severance provision exists.

If such a provision exists, make sure to provide the employee the severance pay that was negotiated when they were employed. Valid signatures should be included in the contract to show that the employee agrees to the conditions at the period of onboarding. The severance plans should be drafted under a lawyer's guidance. Moreover, if you see anything in the contract that you don't understand, consult a lawyer for clarification.

Employees and startups should consider severance package provisions even before forming an employee/employer partnership to avoid unpleasant shocks if and when the relationship fails or falters. The best approach is to hire an attorney before any problems emerge.

Develop an agreement to avoid future legal action

Startups may think about granting a severance compensation in lieu of releasing claims (so that the employees cannot file a suit against the startup later) incorporating a reciprocal non-disparagement provision so that the employees as well as the startup are legally restrained from defaming or bad-mouthing the other.

As a tactic to keep the problem fixed between the employee and the startup, NDAs could be incorporated in the package.

Print your startup's severance agreement in the employee handbook

It is a good idea for startup founders to have a solid severance compensation policy in place that covers all employees.

Experts suggest including it in your current employee handbook if you haven’t already done so. Incorporate severance pay details in employee handbooks, along with paperwork from the time of hiring. As per SHRM, you could include a flowchart with the precise figures that should be expected. 2 years of service, for example, might entitle an employee to four weeks of basic salary.

Spell the terms out clearly

Employees must get timely and concise information. Moreover, spoken or other written material cannot be in sharp contrast with the startup’s severance compensation policy.

As a result, employers must take sufficient initiatives to maintain that employees are not just aware of the severance payment processes and have the chance to ask questions about it, but also that high-ranking team members are appropriately trained to answer employee enquiries about the severance policies.

Key Considerations

Different types of Severance Compensation

Severance pay does not always occur by way of monetary compensation.

While most severance packages do comprise monetary compensation, consider the following examples of severance compensation:

• Money: Money is the most crucial sort of severance for most employees. This is frequently a week or two's compensation for every year that the employee has been with the startup.
• Insurance: Some startups will offer to keep employees' healthcare benefits in effect for a limited time. Many states have passed laws that mandate employers to pay for insurance for a limited time, while many just require startups to continue to provide access to coverage while not paying for it.
• Unemployment: Unless an employee was fired for substantial misbehavior, he or she may be eligible for unemployment compensations.

Summary

You're unlikely to offer - of your own accord - severance to an employee who's been fired for a strong reason. Nevertheless, if there is a severance clause in your employment contract or a widely accepted business policy, you must pay it. In some circumstances, negotiating a severance compensation in exchange for a written waiver agreeing not to sue you or your startup may also be a good idea.

Good employers understand how terrible layoffs can be for both impacted and remaining employees, and therefore do not treat them lightly. As an employer, you must show that the layoffs have a recorded, valid business cause. At the same time, you should justify that you’re not firing professionals on the basis of discriminatory grounds such as gender, age, ethnicity, and nationality, etc.

Founders and HR experts usually agree on a methodology for calculating an efficient and reasonable severance package considering the conditions.

Conclusion

Many people ask for severance payments based on their years of employment, which typically adds up to one to two weeks of salary per year of service. Severance payments are typically detailed in a contract of employment, along with other terms including whether the employee is compensated for unused days of vacation if they leave the startup before the expiration of their contract, what kind of notice a startup must provide them before terminating a contract, and so forth.

Regrettably, an overwhelming number of people in the United States do not have an employment contract. In these circumstances, individuals may not even be aware of their severance rights. In more reasonable times, employees could've expected to receive 2 weeks of severance for each year of service if a co-worker had received the same. But with so many job losses linked with COVID-19, it appears that precedent is losing its relevance.

We can help!

At AbstractOps, we help early-stage founders streamline and automate regulatory and legal ops, HR, and finance so you can focus on what matters most - your business.

If you're looking for help with understanding severance packages for your startup, we have got your back. Sign up to get started.

Note: Our content is for general information purposes only. AbstractOps does not provide legal, accounting, or certified expert advice. Consult a lawyer, CPA, or other professional for such services.

Citations

• The Layoff Payoff: A Severance Package
• What to Expect in a Severance Package
• Severance Pay| U.S. Department of Labor
• 9 Things To Know About Your Severance Package

• More Small Business Articles