In 2023, a Hangzhou startup completed its Series A financing at a valuation of RMB 300 million. At the same time, an additional clause was attached to the investment agreement: the founder and CTO had to continue serving full-time for at least four years after the financing. The investor viewed this as standard practice, while the founder felt it was “too restrictive.” The two sides eventually compromised, lowering the term to three years. But what no one expected was that, a year and a half later, the CTO left in anger over a strategic disagreement with the CEO. Once the news broke, the next financing round immediately stalled; the already-agreed Series B valuation plummeted from RMB 500 million to RMB 200 million, and the investors even proposed valuing the company at 60% of the previous round or simply demanding a repurchase. The founder team fell into a passive position overnight.
This real case reflects a harsh reality: in the software industry, the personal ability and industry influence of core technical personnel are often a significant component of a company’s valuation. The coming and going of a single key person is enough to fundamentally change a company’s fate. This is why every professional investment agreement should contain a severely underrated yet crucial clause—Key Person Clause (core technical personnel lock-up clause).
I. Who Are the Core Personnel (Key Persons)? Legal Definition and Lock-Up Mechanism
1. Scope of Key Persons
A key person is not a strictly statutory concept, but a contractual term developed in investment practice. According to industry practice and judicial experience, key persons typically include the following types:
- Founding core technical personnel: founders or early core members serving as CTO, chief architect, technical director, etc., who master the company’s core technical architecture and code base;
- Key algorithm/model developers: key engineers in AI, big data, and other fields who master core algorithms or trained models;
- Industry leaders: individuals with high recognition and influence in a niche technical field, whose personal brand directly brings business opportunities and talent attraction to the company;
- Holders of key patents/IP: individuals who hold the company’s core patents, software copyrights, and other intellectual property rights.
In practice, the scope of key persons should be specific and clear, avoiding generalized expressions such as “core technical personnel” or “chief R&D lead.” The best practice is to list, in tabular form in an appendix to the agreement, each key person’s name, ID number, position, core contribution area, and corresponding equity/option holdings.
2. Legal Basis of the Lock-Up Clause
Under Article 84 of the newly revised Company Law, effective July 1, 2024, where a shareholder of a limited liability company transfers equity to a person other than a shareholder, it shall notify the other shareholders in writing of the quantity, price, payment method, and term of the equity transfer, among other matters. This provides a legal basis for imposing restrictions on equity transfer.
Article 465 of the Contract Book of the PRC Civil Code provides that contracts formed in accordance with the law are protected by law. As part of a shareholders’ agreement or investment agreement, the Key Person clause is legally binding as long as its content does not violate the mandatory provisions of laws and administrative regulations. Article 22 of the Labor Contract Law further supports the stipulation of a service period—where an employer provides special training funds to a worker for professional and technical training, it may conclude an agreement with that worker to stipulate a service period.
However, it should be noted that the service period under Article 22 of the Labor Contract Law is premised on “specialized training,” and the legal nature of the service-period commitment commonly seen in the software industry based on equity grants (vesting schedule) must be distinguished from the service period in the sense of the Labor Contract Law. The Key Person clause in an investment agreement is closer to an agreement among shareholders on the founder’s service obligations, and its binding force is based on the shareholders’ agreement rather than the labor contract.
3. Design Elements of the Lock-Up Mechanism
A complete Key Person lock-up clause typically contains the following elements:
- Service term: the minimum number of years the key person must continue to serve at the company, typically 3–5 years after the financing is completed;
- Full-time commitment: the key person may not serve in a full-time or substantive role in any other entity (except for passive investment shareholding);
- Time commitment: the key person must devote their primary time and energy to company affairs, typically agreed at no less than 40 hours per week;
- Non-compete: the key person may not engage in activities that compete with the company’s business during the service period and for a certain period after departure;
- IP ownership: all intellectual property created during the key person’s tenure belongs to the company.
Quick Statutory Reference
Article 84 and Article 86 of the newly revised Company Law (equity transfer and register of shareholders)
Article 465 of the Contract Book of the PRC Civil Code (binding force of contracts)
Article 22 of the Labor Contract Law (service period), Articles 23–24 (non-compete restriction)
II. What If a Key Person Leaves?—Triggering Events and Legal Consequences
1. Types of Triggering Events
The triggering event in a key person clause is not merely the simple concept of “departure”; in practice it is usually distinguished into the following categories:
- Voluntary departure: the key person voluntarily terminates the employment relationship, for whatever reason;
- Termination for cause: the key person is lawfully dismissed by the company for violating laws and regulations, the articles of association, or labor discipline, including disclosure of trade secrets, breach of non-compete obligations, gross dereliction of duty, etc.;
- Termination without cause: the company terminates the employment relationship with the key person without statutory or agreed grounds;
- Death or loss of capacity: the key person loses all or part of their working capacity due to death, serious illness, or accident;
- Actual inability to perform duties: although nominally employed, the key person is in fact unable to perform their duties due to reasons such as criminal detention, prolonged loss of contact, or severe mental disorder.
2. Legal Consequences of Different Triggering Events
Different triggering events should correspond to different legal consequences; this is the core technique in designing a Key Person clause:
| Type of Triggering Event | Equity Treatment | Typical Repurchase Price |
|---|---|---|
| Voluntary departure (without just cause) | All unvested equity is terminated; vested equity is repurchased at a “penalty price” | 50%–80% of investment cost or net assets |
| Termination for cause | Unvested equity is terminated; vested equity is repurchased at the lowest price or directly reclaimed | Nominal price (e.g., RMB 1) or 30%–50% of investment cost |
| Termination without cause | Unvested equity accelerates (in whole or in part); vested equity is priced fairly | Fair value or a reasonable percentage of the most recent round’s valuation |
| Death or loss of capacity | Unvested equity accelerates (treated in good faith); vested equity is priced normally | Fair value or as agreed through negotiation |
It is particularly worth noting that the definition of triggering events often has gray areas. For example, when a key person resigns citing “health reasons” but in fact joins a competitor, the clause needs to set out a corresponding burden of proof and investigation mechanism to prevent abuse.
3. Investor Protection Measures—VAM and Valuation Adjustment
For investors, the impact of a key person’s departure is not only a matter of team stability, but directly relates to the erosion of investment value. Therefore, the Key Person clause is usually linked with the following protective measures:
- Anti-dilution adjustment: after the key person leaves, the investor’s previous round of investment automatically triggers the anti-dilution clause, recalculating the shareholding ratio at a lower valuation;
- Veto right over subsequent financing: after the key person leaves and before a new key person is in place, the investor has the right to veto the company’s new financing plan;
- Board seat adjustment: the investor has the right to appoint additional directors, or even obtain a majority of board seats;
- Triggering of redemption right: the investor has the right to require the company or the founder to repurchase all or part of its equity at the agreed price.
III. “You Leave, but the Code Stays”—Design of Knowledge Transfer Obligations
1. The Special Dilemma of the Software Industry
The software industry has a unique paradox: on the surface, code, documentation, and design diagrams are all company assets, but in reality, only the person who wrote much of the core systems truly understands them. This “dependency on the human brain”—where the company’s core technical assets substantively depend on the memory, experience, and intuition of specific individuals—is one of the greatest hidden risks faced by software startups.
A friend who once worked in post-investment management shared a case: after the portfolio company’s chief architect left, the team discovered that the core module of the entire payment system had no documentation, the code comments were all in Russian (the architect was of Russian origin), and a large number of self-created non-standard design patterns were used. In the end, the company spent nearly a year and over RMB 5 million to complete the re-engineering of the system. During this process, the product’s normal iteration almost entirely stalled.
2. Contractual Design of Knowledge Transfer Obligations
Based on the above predicament, we recommend incorporating systematic knowledge transfer obligations into the key person clause, covering at least the following aspects:
- Documentation obligation: the key person must establish and maintain complete technical documentation for the systems they are responsible for during their tenure, including but not limited to architecture design documents, interface documents, database design documents, deployment and operations manuals, etc. This documentation should meet the standard that “another engineer with equivalent competence can independently understand and maintain the system based on it”;
- Knowledge transfer period: when the key person plans to leave, they must complete knowledge transfer before formally departing, including face-to-face handover with the successor for no less than a specified duration (typically 1–3 months), participating in technical reviews, and answering the successor’s questions;
- Handover acceptance criteria: whether knowledge transfer is complete should be accepted by a technical lead designated by the company or an external expert, and the acceptance criteria should be clearly agreed in the agreement;
- Post-departure consulting obligation: within a certain period after departure (typically 3–12 months), the key person should provide technical consulting support, free of charge or at an agreed rate, within a reasonable scope, to assist in handling legacy issues of the systems they were responsible for before leaving.
3. Performance Guarantee of Knowledge Transfer Obligations
Knowledge transfer obligations on paper will become empty words without effective performance guarantee mechanisms. We recommend the following means:
- Linking equity vesting to knowledge transfer: tie the vesting conditions of part of the equity to the degree of completion of knowledge transfer; if knowledge transfer is incomplete, the corresponding proportion of equity shall not vest;
- Installment payment of severance: divide the severance pay (if any) or equity repurchase price into two or three installments, with the final installment paid after knowledge transfer is accepted;
- Liquidated damages clause: stipulate that if the key person fails to perform the knowledge transfer obligation, they shall pay liquidated damages. The amount of liquidated damages should be reasonable, with reference to the value of their unvested equity or a certain multiple of their annual salary.
IV. Equity Acceleration/Forfeiture Mechanism—the “Ultimate Weapon” of the Key Person Clause
1. Vesting Period and Acceleration/Forfeiture
Phased equity vesting is one of the mechanisms most familiar to entrepreneurs. A typical scheme is: the founder holds 40% of the company’s equity, but does not obtain it all at once; instead it vests in installments over four years, with a one-year cliff in the first year. This means that if the founder leaves within the first year, they will not receive any equity.
The key person clause is deeply bound to the phased vesting mechanism, forming a “reverse vesting” or “acceleration/forfeiture” mechanism. Specifically:
- Departure with fault: where the key person leaves by voluntary departure (without just cause) or termination for cause, their unvested equity is immediately terminated, and the vested equity is repurchased by the company or a designated party at a penalty price;
- Departure without fault): where the key person leaves due to death, loss of capacity, or termination without cause, their unvested equity may accelerate (in whole or proportionally), and the vested equity is handled at fair value.
This differentiated treatment accords with the principles of fairness and good faith in the civil law. Article 6 of the PRC Civil Code provides that civil subjects engaging in civil activities should follow the principle of fairness and reasonably determine the rights and obligations of all parties. Article 7 provides that civil subjects engaging in civil activities should follow the principle of good faith, uphold honesty, and honor their commitments.
2. Determining the Fairness of the Repurchase Price
The most sensitive issue in the acceleration/forfeiture mechanism is the determination of the repurchase price. If the price is too low, it may be deemed manifestly unfair and thus revoked under Article 151 of the PRC Civil Code. If the price is too high, it loses its restraining effect on the founder. In practice, the following pricing methods are relatively common:
- Fair value method: the repurchase price is determined based on a valuation report issued by an independent third-party appraisal institution, suitable for no-fault departure scenarios;
- Investment cost method: based on the investment amount paid by the investor, the value of the corresponding equity is calculated by shareholding ratio; this is the most common agreed price;
- Net asset method: the per-share price is determined based on the company’s most recent audited net assets, usually applicable where the company is poorly operated;
- Penalty discount method: a certain discount (e.g., 50%–80%) is applied on the basis of the investment cost or fair value, suitable for fault departure scenarios.
3. Contested Issues in Practice
In recent years, disputes involving key person clauses have gradually increased; the following focal points of dispute deserve special attention:
- Determining the nature of the reason for departure: the founder claims to have been “squeezed out” and had no choice but to leave (asserting Good Leaver status), while the investor considers it a voluntary departure (Bad Leaver). When hearing the case, the court will comprehensively examine evidence such as board resolutions and email exchanges to determine whether there was substantive squeezing-out conduct;
- Reasonableness of the scope of non-compete: an overly broad non-compete scope may be deemed invalid. Under Article 24 of the Labor Contract Law, the scope, region, and duration of a non-compete restriction are agreed between the employer and the worker, but may not violate the provisions of laws and regulations. Generally, the non-compete period may not exceed two years;
- The performing party of the repurchase obligation: when the company is unable to repurchase, the investor usually requires the founder to bear joint and several repurchase obligations.
V. Summary of Practical Points
Explicit enumeration and appendix management
List each Key Person’s identity information, core contribution area, and equity holdings one by one in an appendix, avoiding vague expressions.
Classified treatment and differentiated handling
Set differentiated legal consequences according to the different natures of the reason for departure (voluntary/involuntary, at fault/without fault), reflecting the principle of fairness.
Knowledge transfer and mandatory guarantee
Write the documentation obligation, knowledge transfer period, and handover acceptance criteria into the clause, and support performance with economic means.
Valuation adjustment and linked protection
Link the Key Person clause with investor protection measures such as anti-dilution, redemption rights, and board adjustment to form a complete protection system.
Fair price and avoidance of losing rights
The design of the repurchase price should strike a balance between restraining effect and legal validity, to avoid being revoked for manifest unfairness.
Risk Warning
- Risk of the clause being deemed invalid: excessive restrictions may be deemed to limit a worker’s freedom to choose employment and thus be invalid for violating the mandatory provisions of the Labor Contract Law. It is recommended to place the core restrictions at the shareholders’ agreement level, and include only reasonably scoped service periods and non-compete restrictions in the labor contract.
- Risk of manifest unfairness: an excessively low penalty repurchase price or an overly heavy knowledge transfer obligation may be deemed manifestly unfair and revoked by the court under Article 151 of the PRC Civil Code.
- Risk of difficulty in actual enforcement: even if the case is won, if the key person has already transferred the equity or lacks enforceable property, the judgment may be difficult to enforce.
- Irreversibility of business relationship breakdown: the triggering of a Key Person clause often means a complete rupture between the founder and the investor; although litigation may recover part of the economic loss, it is difficult to repair trust.
VI. Action Recommendations
Advice for Entrepreneurs:
- Proactively propose a reasonable version of the Key Person clause at the financing negotiation stage, demonstrating good faith and professionalism, to avoid passively accepting harsh terms later;
- Maintain a clear awareness of your own irreplaceability in the company—if your departure would indeed cause a sharp drop in the company’s valuation, then proactively drive knowledge transfer and talent pipeline building, which protects both the company and yourself;
- Before signing the agreement, have a professional lawyer review the clauses, paying special attention to the definition of “departure triggering events” and the calculation method of the “repurchase price”;
- Establish an internal technical documentation and knowledge management mechanism to transform individual capability into organizational capability—this is the fundamental way to reduce Key Person risk.
Advice for Investors:
- During due diligence, fully assess the dependency on core technical personnel, identify “single points of failure,” and use the assessment results as a basis for investment decisions and clause design;
- The Key Person clause should not only lock in the founder, but also drive the company to establish a talent redundancy mechanism and a knowledge management system;
- Pay attention to the enforceability of the clause—overly harsh clauses may not be supported in judicial practice; one should pursue what is “reasonable, sensible, and lawful”;
- In post-investment management, continuously monitor changes in the key person’s status, including departure intentions, family plans, and competitive movements, and prepare response plans in advance.
Advice for In-House Counsel:
- Establish standardized templates and negotiation guidelines for Key Person clauses, providing differentiated solutions according to different financing stages and the importance of key persons;
- Periodically review the employment status of key persons and the equity vesting progress, to ensure consistency between the clause settings and actual performance;
- When a key person departure event occurs, promptly initiate contract review and evidence preservation, assess the applicability of the triggering clause, and formulate a response plan.
The true significance of the key person clause is not to “tie” the founder to the company, but to establish a clear and predictable framework for both investors and founders—it tells everyone who the core of the company is and how to handle things after the core leaves. A good Key Person clause is protection for the investor, a warning for the founder, and a safeguard for the company. It should not become a tool for one party to suppress the other at the negotiating table, but a consensus between both parties to rationally manage the risk of core talent.
Disclaimer
This article is for general reference only and does not constitute legal opinion or advice. For specific legal issues, please consult a professional lawyer. The cases in this article are adapted from real events, and the company names and details involved have been anonymized.
Lawyer Kevin Jun Lin
Senior Corporate Lawyer · Industry Legal Practice Expert
💬 Feel free to share your views and reasoning in the comments
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About the Zhenpin Lawyer Team |
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Lawyer Kevin Jun Lin — Today’s Author Currently a doctoral candidate in civil and commercial law at China University of Political Science and Law. Combines deep theoretical knowledge of company law with extensive practical experience, specializing in company law, shareholder disputes, corporate compliance system building, data compliance, and product quality disputes. |
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Lawyer Yan Ge: founding partner of the law firm, with decades of frontline legal experience, possessing hands-on practice across the four dimensions of courts, supervision, justice, and enterprises. |
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Lawyer Lin Bing: 27 years in practice, with a dual background in law and finance, having handled over 2,000 litigation and non-litigation matters. |
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