July 31, 2020
Running a startup is a challenge with an almost constant barrage of important questions to answer. What marketing strategy should we adopt, where do I find investors, what if my company runs out of money, and the biggest question of all – will anybody actually buy our product or service?
However, one thing not widely discussed is what happens if and when co-founders split up?
Many entrepreneurs treat their start-up as a ‘baby’, so the thought of one of the ‘parents’ leaving that ‘baby’ does not always come to mind, especially when it has not even taken its first steps into the big wide world.
Regardless of the phase your business is in, a split between co-founders will have a significant impact on what you’re trying to build and there are a couple of crucial points that every founder should keep in mind:
Nearly 35% of co-founders leave the company at some point, and this usually happens within two years of the first investment round. There are many reasons why a founder might decide to leave: it can be stress, disagreement on strategy, or it may be something completely non-work related (such as taking care of a real baby). Regardless of the reason, it is always a good idea to talk things through and try to come to a mutual understanding (easier said than done but this is really crucial).
Catering for this scenario is like a prenup: no one thinks it is useful or wants to spend time and money putting one together, until they find out that one of the founders has been secretly dealing with a new investor and is about to leave to have another ‘baby’. Even if the business is run by family or friends, it’s worth having an agreement that stipulates the founders’ responsibilities and provides direction for situations like a split up.
This second point is crucial because what happens when one of the co-founders decides to leave a startup depends on whether there is an agreement between them or not.
Many agreements will include a ‘reverse vesting’ mechanism’ which shows how many shares in the business can be retained if a founder leaves.
If this is in place, the first step typically includes a determination of whether that co-founder is a ‘good leaver’. Typically, a ‘good leaver’ will have to transfer the shares back to the company for their ‘market value’ or keep some percentage of the shares and transfer the rest. A ‘bad leaver’ generally cannot keep any shares and has to transfer all of the shares back to the company at a nominal value.
You can define ‘leaver types’ as you wish and even create additional terms such a ‘very good leaver’, ‘medium leaver’, or even ‘very bad leaver’.
Once you have decided what type of leaver your co-founder is, you need to prepare and file the necessary legal documentation. The remaining team may want to find a replacement for the leaving founder, especially if they brought some specific experience and expertise to the business.
It can be beneficial to involve a mediator at this stage to ensure discussions on the split run smoothly and things like non-competes and non-solicits in the agreement are adhered to.
In cases where there is no agreement, things can (and often do) get contentious. Big issues often arise when a leaving founder remains a significant shareholder.
This can cause a lot of aggravation to the other founders as there’s no guarantee the leaver still has the best interests of the startup in mind. Additionally, they may have the ability to use their votes to oppose important decisions and disrupt the growth of the business.
As a growing business ourselves we understand the struggles cofounders face. If you want to discuss co-founder agreements and find out how we can support your business through a split up, please get in touch.