You and your co-founder spent months, if not years, building your company. You worked side-by-side (or perhaps remotely) for more hours than you care to count, and you both made significant contributions that you can directly attribute to the business’s current position in the market. You were both committed to doing whatever it took to succeed; but, now, your co-founder wants to leave. In fact, he or she is requesting a buyout from the company.
What do you do?
The departure of a co-founder can be a complicated situation even under the best of circumstances. In an ideal scenario, the company will have documentation in place that clearly prescribes the mechanisms and procedures for buying out a founding owner. But, even when this is the case, startups will often lack the liquidity required to complete a buyout outright. When the company’s documentation is inadequate (or non-existent), there are even more questions that must be answered to everyone’s satisfaction in order to avoid a costly (and potentially business-ending) dispute.
Key Questions When a Co-Founder Demands a Buyout
Are You on the Same Page?
One of the first, and potentially most important, questions is: Are you and your co-founder on the same page? In other words, are you on good terms, and are you prepared to have him or her exit the company? If the split is amicable, you stand a far better chance of negotiating a mutually agreeable buyout that protects your company’s critical assets and maintains its current trajectory.
If you do not want your co-founder to leave – whether because you believe he or she is critical to the business’s future or you do not want the company to take the financial hit from a buyout – you could be facing a tricky situation. Likewise, if you and your co-founder are fed up with one another and he or she wants to bleed the company for as much money as possible, the split could become contentious (not to mention costly). The terms of your Shareholder Agreement and other governing documents will be critical, and you need to understand their implications sooner rather than later.
What Governing Documents and Agreements Do You Have in Place?
When you and your co-founder formed the company, what documentation did you put in place? Do you have a Shareholder Agreement and bylaws (or Operating Agreement if you formed a limited liability company)? If so, what does it say about buyouts? Is your co-founder entitled to demand one? On what terms? How is the company as a whole, and his or her ownership interest, to be valued? Does selling his or her shares necessarily mean loss of management and control rights as well? Or, will this need to be addressed separately?
If your co-founder started working on your product before you formed the company, did he or she sign an Intellectual Property (IP) and Technology Assignment Agreement? If not, any IP assets (such as trademarks, inventions, software code, and media content) that your co-founder created prior to the company’s formation may be his or hers to keep. Is he or she willing to give them up? If so, at what price? Does the agreement address post-formation IP creation as well? These can be sticky issues that can lead to very real business viability concerns for remaining founders.
As a related issue, is your co-founder subject to confidentiality and non-competition covenants under the terms of any of your governing documents or agreements? If not, is he or she planning to leave and start a competing business? What rights (if any) do you have to prevent that from happening?
Has Your Co-Founder’s Stock (or Membership Interest) Vested?
In some circumstances, co-founders may choose to include vesting provisions in their Shareholder and Membership Agreements. Under these provisions, the company retains the right to buy back all or some of the founders’ respective ownership interests until a certain event or point in time. If your co-founder’s shares have not vested (i.e., the event or point in time has not yet been reached), the terms of the buyout should be fairly straightforward and your co-founder’s leverage should be minimal.
How Will Your Company Fund the Buyout?
Maybe your startup has the cash on hand to buyout your co-founder’s shares. If so, great, you are in a better financial position than most startups out there. But, if you do not (or if you do not want to deplete your company’s cash reserves), your company will need to look for alternate sources of funding to complete the buyout.
What options are there? Finding a new partner is one possibility. Your new partner could either buy your co-founder’s shares outright, or he or she could make a capital contribution (in exchange for the issuance of new shares), which the company then uses to pay your co-founder. Seeking outside investment is another option (assuming the timing is right); but here, too, there are several important legal considerations involved. You could also look into debt funding, either from a financial institution, from you, or from family and friends.
Do You Want to Consider Purchasing the Shares Instead?
Depending upon the circumstances at hand, it may also be worth considering whether you want to buy your co-founder’s shares instead of effectuating a buyback through your corporation or LLC. Why might you want to consider this? Lack of capital within the company is one reason, but tax implications, your goals with regard to securing outside investment, and numerous other factors could potentially weigh in favor of you buying out your co-founder as well. Of course, this is not a decision to be taken lightly; as with all of the issues discussed in this article, you will want to review your options with an experienced attorney.
Is Your Co-Founder Willing (or Obligated) to Sign a Release?
When the buyout is complete and your co-founder has left the business, you want to be confident that the split is completely clean – in other words, there are no loose ends that could lead to your former co-founder filing a claim against the company. The primary tool for protecting your company in this situation is a Release Agreement.
Why would your co-founder be willing to sign a release? You (or, technically speaking, the company) may have the leverage to demand a release if your co-founder does not have a clear right to force a buyout at his or her desired valuation. Your Shareholder Agreement or Operating Agreement could also require a release (or include a self-executing release) as a condition of buying back a co-founder’s shares. Note, however, that your co-founder may also seek a release and indemnification from the company to avoid the risk of personal liability in the event that your company gets sued down the line.
Speak with Attorney Jiah Kim About Your Co-Founder’s Buyout Request
As you can see, there is no single, straightforward solution to addressing a co-founder’s desire to leave. If your co-founder has requested a buyout, the first step toward understanding your options is to undertake a careful review of all of the governing documents and agreements that your company has in place. For more information, and to get legal advice custom-tailored to your unique personal and business circumstances, call (646) 389-5065 or schedule a consultation with attorney Jiah Kim online today.
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When multiple individuals come together to create a startup from scratch, they see a collective dream, a dream of scaling together and creating their own signature in the market.
But the twists and turns in life might cause a rift between the founders and lead to a fallout. The reasons may vary, but how the rest of the people handle this ‘crippling’ situation will be crucial to the startup's survival.
At any stage of a business, this situation can affect the normal flow of the company and may cause many internal and external disputes if not properly dealt with.
Over the years we have seen many faces of founders leaving companies, and we would like to share what we have learnt through this blog.
Let's jump right in.
Table of Contents
8 Reasons Why Co-founders Leave
Co-founders leaving startups is not an uncommon phenomenon in the tech world. Ever heard of Ronald Wayne? He was a co-founder of Apple who exited the company in its early stages.
He got a whopping $800 as a payoff.
This is a classic example of a co-captain jumping ship; in most cases, the reason may be justifiable for personal or professional reasons. At the end of the day, they are human beings; we have to take time to understand the reason first. But most of the time, conflict of interest will be the reason rather than unavoidable obligations.
1. Personal Reasons
There are many personal reasons that can affect a person's productivity. Like a disease or something. When the co-founder believes that he cannot contribute to the company's development, they will choose to resign or refrain from the co-founder role.
Many retire after making a sizeable savings for their future and tend to enjoy the rest of their lives rather than succumb to the pressure of running a company. These are just some of the personal reasons on top of my head; there can be many variations for this.
2. Co-founder not scaling with the company
A startup won't remain a small company for long; as the company grows, the responsibilities of a founder will also grow. A founder should be a person who can be adopted to this change and have the skillset to lead from the front.
In most cases, the title of the co-founder is given to anyone who was with the company during its start. So when the company increases in size, they have to provide value to the company, or they will become underqualified to handle the responsibilities of a co-founder.
Also Read: 9 Top Team Management Skills That Make You a Great Leader
There are two ways to tackle this conflict of interest:
One is solely based on how you choose your co-founder. Never choose a co-founder for the present requirements but as a future partner. So that their skills would be an essential part of your startup even after you scale.
Two, you need to have the “talk” with your co-founder at the time of inquisition about the possible scenario of a more experienced candidate occupying his position.
This might be an uncomfortable topic to talk about, but this move might save a lot of hassle in the future.
If you are unable to come to a resolution and the person does not choose to leave voluntarily, the termination process will be messy.
3. Burnout
Burnout comes into play when there is an imbalance in work allocation. Here one co-founder plays way too many roles in the company. This pulling of others' weight will exhaust them completely. Most of the time, a conversation might solve this, but due to the awkwardness of the situation, most refrain from it and later cause friction in their professional relations.
Later on, the co-founder burns out and leaves the startup. Like in any relationship, communication is key, and this takes predominance in a business. The risks you take, the hours you spend, everything needs to be shared, and a transparent line of communication needs to be maintained.
4. Better opportunities
When a co-founder gets better opportunities or has their own business plans to pursue, they abandon ship. But this transfer comes with a mutual understanding and doesn’t always become messy.
In case this scenario gets out of hand, it will be the messiest problem of them all, with intellectual property theft and a whole lot of formalities leading to many legal conflicts.
There are scenarios in which one co-founder loses interest in what they are doing and looks for opportunities that excite them.
5. Monetary concerns
When you are building startups, the initial phases won’t be profitable as you think; most of the time, it will be consuming more money than it's making.
At that time, co-founders will be made promises that once the company scales, they would get the compensation befitting the growth of the company.
Without a written contract, the expectation based on the promises might not meet the reality that happens, and the clash of expectations and reality will prove to be the reason for a co-founder leaving the company ranks.
6. Illicit reasons
Though this reason is rarely seen, we can never rule out the possibility of it. Co-founders have faced the situation of intellectual theft, ask the Winklevoss brothers. ( Oh! You can’t go because of Zuckerberg’s Non-disclosure settlement.)
There are people who start working hand–in hand with a company during its initial phases and learn all about its trade secrets only to jump ship and make a company on their own.
These kinds of “humane” attributes have made legal contracts an unavoidable part of startup culture.
A startup founder has to be wary of whom he presents his ideas and be secretive about their unique selling points.
7. Laying off
When there is a dip in the financial situation of a company it is common for employees to be laid off and the people terminated are the ones in the top hierarchy.
People working at the bottom level are necessary for the company to work properly and with the salary of managerial people, you can employ a fresher with half their salary as the managerial process would be refined by then and you would just need a person to co-ordinate it.
As a co-founder, the shares and equity would complicate his termination but sometimes that would be a better option than taking a company.
8. Death
Human beings are very fragile creatures and the pandemic has etched that in stone. In case there is an event that leads to the death (touch wood) of a co-founder then it is beyond our hands.
The Three Stages of Co-founder Exit Strategy
The first thing you have to understand is that when a co-founder leaves the company it doesn’t mean the end for your precious brainchild. The goal here is to treat it like a high priority transition process.
Though a co-founder is an integral part of the company, “the show must go on”. Let's take a look at this in three stages.
1. “Prevention- Better than a cure”
Before you start working on your startup, it’s always good to have a written contract that everyone agrees on. Settling the technicalities beforehand will give you peace of mind and a sense of security.
The initial contract must have the shares they will receive, the pay off percentage, non-disclosure, notice period and details regarding the usage of company knowledge
Serving the notice period is mandatory for a co-founder as he should train their predecessor and educate the new candidate about the processes in the company.
In the majority of companies, if a co-founder expresses their intention to leave, the rest of the founders will try to negotiate terms with them, like increasing their compensation or their stakes, etc. if the co-founder is a valuable asset to the company, the company will want him to stay.
Forgetting all this, the normal structure of a company is constructed in such a way that there is always a backup in case a person from a managerial role exit. That backup would be a person who acts on behalf of the co-founder when he is on leave or a person who takes the decision in case of his absence.
2. “Endure the present & the future shall be bright”
The process of a co-founder leaving the startup is very hard for the company, this is the time where communication with your fellow employees is crucial. This drastic change in management needs to be properly conveyed to them to build transparency and trust.
The same information must be conveyed to the stakeholders, investors and your key stakeholders. The investors need to be regularly updated with the important events in your startup, and a co-founder exiting is a huge update that changes the dynamics of the business.
This instils a sense of trust with the investors, and they might even try to help you find a suitable replacement or give you advice on your next step.
A co-founder leaving a company is not similar to a regular employee leaving, if he is a board member, the whole board needs to vote on his termination and there are several other complications that may pop up.
In order to avoid that, it is better to do the process in the presence of an attorney. They will help you with the best co-founder exit strategy with the best legal advice.
A legal attorney is also needed when determining the state of equity entrusted to the co-founder. This solely depends on the agreement which “should” be made before you divide the shares.
Either they can keep or sell the stocks. Most of the time company repurchases the shares from them before they leave. Prior notice will be issued to the exiting co-founder to inform them that the company is willing to repurchase their unvested shares.
3. “A cure for the void”
When a founder decides to leave, the remaining co-founders must devise a strategy to help the company through that phase. Selecting the right person to fit those shoes might be challenging in some cases as that is the value provided by their predecessor.
Every company starts their search for a replacement internally first. A person who is familiar with the company and its processes will save the company time and resources. As the role played by a co-founder is leaned towards the managerial point of view, a familiar face in that position would be comfortable for everyone.
If the situation arises when you can’t find the right person for the job internally, external hiring is the only option. Here the co-founder who is about to leave the company will serve the notice period training the new employee.
But bringing a new talent takes time and will depend on many factors. The hiring process will take more time than a regular employee acquisition considering the importance of the shoe they have to fill.
Takeaway
A co-founder leaving your company is not the “inevitable snap” of Thanos; it is just another hurdle in your startup journey.
The way you handle the situation is the key to a prospective future. The key takeaway you can get from this is blog is that you should always have a backup plan and be ready for any unforeseen circumstances.
We know these are the type of situations when your mind presses the panic button. But as a co-founder, your team is looking up to you, and it’s your duty to be the bedrock for them.
Keep in mind what you have learnt through this blog, and never try to do everything alone. Look for help when you need it.