I recently took a discovery call from a startup founder who wanted advice on how to separate from her co-founder:
My co-founder and I are having irreconcilable differences.
He expects an increase in 25% in his equity share when he simply isn’t pulling his weight — and it’s just ludicrous!
I put in more time than he does, and I’m just tired of him expecting something for nothing in return.
The founder was clearly frustrated. And this frustration was affecting her ability to negotiate. I asked her a follow-up question, “Do you know why your co-founder is asking for an increase in 25% equity? Most people don’t ask for something if they don’t have a clear why.”
She had no answer. Instead, she just continued as she had previously done:
He’s not worth that.
Like I told you, I’m the one putting in more time than he is, I’m staying long hours, and making sure we have the runway to continue operating.
I need to get him to leave the business or I’ll dissolve it.
This founder shows the common problem facing most founders when they breakup: they do it poorly because of heightened emotions.
According to Noah Wasserman, an entrepreneurship professor at the University of Southern California Marshall School of Business, 10 percent of co-founders end their relationship within a year of starting a business and an additional 45 percent breakup within four years.
That’s a lot of co-founder divorce, which if not managed correctly, can lead to the separation getting:
It’s like when a married couple, who hasn’t had sex in years, decides to call it quits, and everything that has gone unsaid for all those years starts to finally come out. For founders it’s the same thing — they go from putting their heart and soul into a company, letting small disagreements or differences go unacknowledged, to suddenly fighting their business partner.
Co-founder splits happen for several reasons:
Whatever the reason, this article is part 1 of 2 that will help you understand what you should be thinking about when going through a co-founder divorce.
I would also recommend copying the Co-Founder Breakup: Checklist of Questions Worksheet to your G-drive and working through the questions separately or together with your co-founder.
These are the same questions I ask potential clients to get clarity on how to move forward with an amicable co-founder split.
The first step in separating peacefully is to see what your partnership agreement says, specifically about the following:
Unless you had a successful valuation, the stock is probably worth nothing.
That makes the last question point the hardest point of the negotiation — especially if the startup still wants to raise money in the near future — because you’ll have to evaluate the potential of the stock.
If you don’t have a founder agreement, or your contract says nothing about any of the bullet points above, you and your co-founders will need to have an open conversation about these points.
Pro Tip: Common law, depending on where you incorporated, may define the separation if there is no founder agreement, but seek legal advice regarding that.
If you do need to discuss buying back a co-founder stock, frame the conversation around fair market value compensation — plus or minus depending on the financial state of the startup. Then structure a buy-out deal with incremental payments over a period of time that everyone can agree to.
Unlike equity, capital is cash — and that is worth something.
Treat any initial capital that a founder put in as convertible debt, as you would a pre-seed investment into the startup. If, however, that was not done and it was treated as a loan to the company, this will make things difficult.
Ask yourself the following regarding the capital each founder put in:
To learn more about the difference between convertible debt versus a loan, read this article: Founder Convertible Notes - Put Your Money on the Cap Table.
Get clear on how the capital was (or should be) treated. Establish how much it was worth to the startup’s financial trajectory. And negotiate either applying retroactive convertible debt or how the startup will compensate the founder for the loan.
Understanding the legal and contractual obligations of separation is one thing, next you have to plan out what the actual separation looks like.
How you separate will define the relationship and have major consequences for the business — so be patient, kind, and generous here.
Angel investors have even been known to call previous co-founders to see if they should invest in a startup. So any bad feelings about the separation process can come back to bite you in the ass.
As Venture Capitalist Fed Wilson suggests, being generous and giving additional severance or vesting stock can make the transition process easier for the separating founder. And help the business thrive, too.
Think about the following when it comes to the transfer process:
As you think about the transition process, think of it like cooking a meal — you get to decide what you want to make and the ingredients that go into it, but ultimately the person eating it (i.e., the separating co-founder) decides how good it tasted. So make something that they will rave about.
Part 2 of this two-part series will discuss the separation process more at length since this is where both founders have the same amount of power relative to one another in deciding the next steps.
Sometimes a founder wants to keep the business alive while another one is pushed out or leaves. Or there is an equal willingness to dissolve the company.
Whichever situation you find yourself, ask yourself the following:
Read this article to get a better idea of the different IP considerations you should be thinking about: Safeguard Your Startup with an Intellectual Property Strategy.
Lastly, is the situation so bad between you and your co-founder(s) that you need help?
Just know that the minute lawyers get involved, things have a way of going from bad to worse. Lawyers always put someone on the defensive, but if there are legal questions that you need answers, please seek legal advice.
Most co-founder disputes occur because the founders have under or miscommunicated. A mediator or a trusted neutral third party advisor can help you separate at the fraction of the cost of an attorney. Make sure the third-party neutral can help you:
Firing someone from an operating role does not automatically delete them from the cap table, their shares are legally their property and must be addressed separately.
Likewise goes if the founder is on the board of directors or holds any officer positions. If this is the case, the company should obtain a short written resignation statement from the departed founder to keep in its records. An email works too.
If the founder is unwilling to deliver a resignation statement, it is critical to consult an attorney. The company should immediately fill any vacant officer positions created by the founder’s departure.
In the end, how you address these issues will affect the separation conversation and how long the process is drawn. So do it wisely with an eye toward a win-win situation.