Founder disputes are one of the most common risks to a young company, but it doesn’t have to be that way. Whether it is a disagreement over a core issue or the waning interest some experience along the startup road, most companies face turnover in their early days, with key players rotating in and out.
While we know, considering the examples of Facebook and Snapchat, that companies can still go on to greatness despite an early founder breakup, that doesn’t detract from the problems that arise when founders leave while holding onto an equity stake.
Under these circumstances, ex-founders can create problems in one of two ways – either they can insist on maintaining influence in a company when they are no longer wanted or they can surface years down the road and claim a right to a company’s success that they had no part in creating. Either scenario is obviously problematic. But there are a few things companies can do to protect against the type of consequences that can arise due to a founder split:
- Don’t Rely On A Handshake: Step one may seem obvious, but it is surprising how often founders ignore the paperwork and barrel down the road in their haste to create the next big thing. The cost of engaging a lawyer to prepare an Operating Agreement for your LLC (or Shareholder Agreement for your corporation) is easily justified considering that you will have a mechanism in place to address issues like key voting decisions, how new members are admitted, or how distributions are divided. Even the task of sitting down with your team members and talking through some of these issues can be critically revealing and bring conflicts to the surface that are better to get out of the way sooner than later.
- Company Buy-Back: Especially for early-stage companies, consider a provision in your governing document that allows the company to buy out a member/shareholder upon majority or super-majority vote. This way, if one of the early members is not working out, there is an agreed upon mechanism to facilitate the breakup, with important issues such as the purchase price owed to the exiting member established by a pre-existing formula.
- Vesting And Reverse Vesting: Another protection for co-founders is to agree to a vesting schedule pursuant to which founder equity will be granted over time or upon the completion of certain milestones. For example, a founder is granted 16,000 units but she only receives them on quarterly intervals over 4 years, meaning she gets 1,000 shares a quarter. In that way, founders will not fully “own” their equity stake until they stay involved with the company over a certain period of time. A similar concept is known as “reverse vesting,” where a founder is granted his or her total equity allotment upfront, but the company is entitled to repurchase shares if the founder leaves.
If you are interested in more detail related to your situation it is best to speak with an attorney.
Megan K. Johnson is a business lawyer with over 7 years of experience. She helped champion securities crowdfunding at the local level and worked with the first company to successfully close an equity crowdfunding involving everyday investors. She is a partner at Founders Legal and can be reached at [email protected]
Source: Smartup Legal