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Changes to unfair dismissal law from January 2027 could have particular significance for venture capital and private equity-backed businesses. Partners Harry Trick, Adam Kean and Jo Mackie look at what the new regime means for investors, management teams and portfolio companies, and the practical steps VC and PE investors should be considering now.
For venture capital and private equity investors, employment law may not be the most obvious area to focus on when assessing an investment. But changes taking effect from 1 January 2027 could make the way portfolio companies recruit, incentivise and, where necessary, part company with founders and senior management a more significant investment issue.
The Employment Rights Act 2025 will reduce the qualifying period for ordinary unfair dismissal claims from two years to six months. At the same time, the existing cap on the compensatory award for unfair dismissal will disappear. Both changes will take effect from 1 January 2027.
That combination matters for investor-backed businesses. Venture-backed companies often need to build management teams quickly and make difficult decisions as the business moves through successive stages of growth. Private equity-backed groups may have established management incentive plans and make management changes as part of a value creation plan, integration or preparation for exit. In both cases, equity is commonly a significant part of management remuneration.
The changes do not prevent those decisions being made. They do, however, increase the potential consequences of getting them wrong.
Why does this matter particularly for VC and PE-backed companies?
- Six months is a relatively short window in which to assess a senior hire
At present, the two-year qualifying period gives employers considerable flexibility when a new hire simply does not work out, subject always to the existing protections against discrimination, whistleblowing and automatically unfair dismissal.
From 1 January 2027, ordinary unfair dismissal protection will apply where the effective date of termination falls on or after that date and the employee has at least six months’ service. Employees who already have six months’ service will therefore gain protection immediately. Unusually, it has retrospective effect.
That puts much greater emphasis on the first few months of employment. This is relevant to both venture-backed businesses recruiting senior executives into rapidly evolving roles and to private equity-backed businesses strengthening or reshaping management teams following investment. Companies sometimes recognise relatively early that an appointment is not working, but delay addressing it.
That delay will carry much greater risk under the new regime.
Investors should therefore expect portfolio companies to be more disciplined about probation periods, objectives and early performance management. A six-month probationary period will no longer provide the comfortable decision-making window it once did, not least because statutory notice counts towards qualifying service. Businesses may wish to use shorter probation periods or earlier formal review points so that concerns are identified, documented and addressed before the threshold is reached.
- The removal of the compensation cap changes the risk calculation
Currently, the compensatory award for ordinary unfair dismissal is capped at the lower of 52 weeks’ gross pay or £123,543. From 1 January 2027, that ceiling will disappear. Compensation will remain based on losses caused by the dismissal rather than becoming punitive, but there will no longer be the same statutory limit on those losses.
For most claims, that may make relatively little practical difference as the vast majority of awards are already below the existing cap. Investor-backed companies, however, are not always dealing with typical remuneration arrangements.
Senior management packages can include salary, bonus, growth shares, sweet equity, employee shareholder arrangements, EMI or other options, and carried or exit-linked incentives. If an unfair dismissal is said to have caused the loss of significant future remuneration or equity value, the potential exposure could be considerably greater than it is today.
The point is not that every unfair dismissal claim will suddenly become enormous. It is that the potential exposure at the upper end could become much more material.
- Equity makes the issue more complicated
Equity is central to both venture capital and private equity models. Founders may hold shares subject to vesting and leaver provisions, while management may participate through growth shares, sweet equity or option arrangements. Termination of employment can have significant consequences under those arrangements, including the loss of unvested awards or the compulsory transfer of shares.
Leaver status may also determine the price payable for those shares. A good leaver may receive market value, while a bad leaver may receive only the amount originally paid or another discounted value. A dispute about the circumstances of a departure can therefore become a dispute about equity value, particularly where the departure occurs shortly before a fundraising or exit.
Where a dismissal is found to be unfair, an employee may argue that the resulting loss extends beyond salary and bonus to the value of shares, options or other incentives affected by the termination. That matters particularly where equity represents a substantial part of the individual’s overall economic interest in the company.
An uncapped award does not mean that a claimant will automatically recover the headline value of the equity they have lost. They would still need to establish that the loss was caused by the unfair dismissal and evidence its value. Vesting, leaver status, exercise conditions, the likelihood and timing of an exit, and the inherent uncertainty of valuing shares in a private company may all be relevant. The extent to which claims involving lost incentive rights will succeed, and how those rights will be valued, remains materially uncertain.
Even so, the potential value of the claim could make disputes involving founders or senior executives more difficult to settle, particularly where the parties take very different views of the company’s future value.
For investors, the practical point is that employment and equity documents should be considered together. Leaver provisions may determine what happens to an individual’s shares or options following termination, but they do not determine whether the dismissal itself was fair. Equally, applying the contractual leaver machinery will not necessarily prevent the individual from seeking compensation for the value allegedly lost.
- Employment disputes can become investment and exit issues
A dispute with a former founder or senior executive alleging substantial losses is not simply an HR problem. For a venture-backed company, it is likely to become a diligence issue on the next fundraising. For a private equity-backed company, it may affect bolt-on activity, refinancing, exit readiness or the sale process.
A new investor or buyer is likely to want to understand the claim, its potential value, the company’s insurance position and whether provision may need to be made for it. Depending on its materiality, it could affect disclosure, warranties, indemnity protection, retention mechanics or the terms and timing of the transaction.
What should VC and PE investors be doing now?
At investment: employment diligence should pay particular attention to founders and key senior management. Investors should understand length of service, contractual terms, probationary periods, equity arrangements, incentive documentation and any existing performance or relationship issues. Where a senior departure is already contemplated, it should be addressed rather than left as a post-investment issue.
In constitutional and incentive documents: founder vesting and management leaver provisions should be considered alongside the changing employment-law landscape. Investors should examine how Bad Leaver status is triggered, whether a pending employment claim delays a compulsory transfer, who determines leaver status and whether the board or investor discretion is clearly drafted and sufficiently robust. A contractual mechanism dealing with someone’s shares does not, by itself, determine whether dismissing that individual is fair.
Across the document suite: articles of association, shareholders’ agreements, service agreements and incentive plan rules often evolve separately. They should be checked together so that definitions, triggers, valuation provisions, transfer timing and decision-making powers align, and so that an employment dispute does not create avoidable uncertainty over ownership or control.
At portfolio level: companies should revisit probation and performance-management processes. Objectives should be identified early, concerns documented and difficult conversations held when they need to be held. This does not mean importing cumbersome HR processes into every portfolio company, but having enough process to demonstrate that important decisions have been taken fairly and for proper reasons.
When making senior hires and contemplating departures: boards should build review points that leave enough time to assess an appointment before the six-month threshold is reached and should take advice early when an exit is under consideration. The economics of a negotiated departure may look different when the alternative is an uncapped claim involving potentially valuable equity.
Preparing for 2027
With the new rules taking effect from 1 January 2027, now is a sensible time for investors to ask portfolio companies whether their probation, performance and senior-exit processes are ready.
The broader lesson is that employment arrangements and management equity structures cannot be viewed in isolation. As more employees gain access to unfair dismissal protection, investors and portfolio companies should review whether their articles of association, shareholders’ agreements, growth share arrangements, option plans and service agreements continue to deliver the intended commercial outcomes.
Review now may help avoid uncertainty and costly disputes at a time when the business is focused on growth, integration, fundraising or exit.
How Michelmores can help
Our Corporate, Employment and Tax teams regularly advise founders, management teams, venture capital investors and private equity houses on management incentive arrangements, growth share structures, leaver provisions and senior exits. If you would like to discuss the impact of these changes on your portfolio companies, governance documents or incentive arrangements, please get in touch.
Hollie Halston
Senior Associate