How to legally protect your business from Co-founder disputes?
In this week’s newsletter, Dragon Argent corporate lawyers in London advice startups on how to legally protect their business from co-founder disputes or managing the exit of a founder.
When you first embark on a business venture, your relationship with your co-founders is based on excitement, ambition, shared objectives, and is full of optimism. The plan is to build a business together, take on some investment, scale up, conquer the world and ultimately sell the company, having retained as much equity for yourselves in the process as possible.
But the startup road is bumpy and the demands of building a business can strain relationships with even the most solid of foundations. The pressure of leading a business can shine a light on personality traits that might have gone under the radar, and previously shared views and objectives can quickly diverge.
Sometimes, the initial excitement and camaraderie can wane. Some founders may not like the pressure of startup life and simply want to move on. Others may be toxic to the business and need to be removed.
In either case, you may find yourself with an ex-founder who is no longer contributing to the business but who is still sitting on a sizeable chunk of equity.
This isn’t ideal, for a variety of reasons. Depending on the number of shares the departing founder retains, they may still have an element of control over the company, or at least the ability to block key decisions. You may also be left with a situation where the remaining founders are working long hours to help enrich someone they have fallen out with. Hardly motivating.
So, what’s the solution?
In the first instance, founder disputes or managing the exit of a founder should be dictated by the terms of the relevant founder’s contract of employment, together with the company’s constitution (i.e. its articles of association and any applicable shareholders’ agreement). We’ve written a separate article about the importance of a company’s constitutional documents and ensuring they are fit for purpose for your business. You can read this article here.
In many instances, founders will have been asked to sign up to terms under which the shares they hold “vest” over a certain period. This means that if they were to leave at any point during that period, a proportionate number of their shares will be clawed back from them.
A lot of founders are nervous to agree to these terms, quite understandably. Institutional investors can often insist on founder vesting as a condition of their investment at a point when those founders have been with the business for several years and have already shown huge commitment to the company.
Founder vesting schedules can therefore be seen as onerous or unfair, as they put into jeopardy the very thing that keeps a founder motivated to struggle on through tough times – a potentially life-changing pay-out on exit.
But another way to frame it is as a reflection of the pact that founders have already made with each other. And should one of them break that pact, why should their co-founder and the business suffer as a result? Sensibly drafted vesting provisions can provide a mechanism by which a founder’s shareholding is adjusted to give a fairer reflection of their (and their fellow founders’) commitment to the business.
However, if a smooth exit can’t be achieved, founders may find themselves in dispute. In this instance, a formal (time consuming and sometimes costly) dispute resolution process may be entered into which, frankly, should be the option of last resort for all parties. We’ve also previously written about dispute resolution in owner-operated businesses and you can find the article here.
If you find yourself in a founder dispute, one of the team at Dragon Argent would be happy to run through the options you have to resolve the situation in the quickest and easiest way possible.
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