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 ludicrous!
She was furious, and was venting to me.
I put in more time than he does, and I’m just tired of him not pulling his weight.
The founder was clearly frustrated. And this frustration was affecting her ability to negotiate. I asked her, “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 just 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 was illustrating the common problem founders when they breakup: emotions unnecessarily clouding judgment.
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:
- Emotionally Chaotic
- Prone to Cognitive Errors
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 unleashing everything.
Co-founder splits happen for several reasons:
- Mismatched personalities
- Different work styles
- Misaligned business visions
- Unequal distribution of work
- Unresolved disagreements
Whatever the reason, this article 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.
Question #1: What does your partnership agreement say?
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.
If you did a valuation, then you and your business partner will have to negotiate the shares' worth. If the startup still wants to raise money in the future, you'll have to evaluate it based on the potential and future worth of the company. Do this with a 1-year to 3-year perspective, whichever you think most feasible. Frame the conversation around fair market value compensation — plus or minus 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.
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.
Question #2: How much capital did each founder put in?
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, you'll need to negotiate those terms.
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. Whichever is better for your situation.
3. What does a transfer process look like to you?
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 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.
4. Are you willing to dissolve the company?
Whether one founder stays on to keep the business alive or the company is dissolved entirely is up to you.
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.
This intellectual property can be used for a future iteration of the company or could be sold to cover debts or pay out a founder.
I was helping one founder that had a business partner use the IP to create a new company without the explicit approval of the former. This created problems. And was prohibited by the founders' shareholder agreement. This lead to a lawsuit for them. Don't be them, and be proactive about how to cover your IP bases as you dissolve the company.
5. Do you need a lawyer or a neutral third-party?
Lastly, is the situation so bad between you and your co-founder(s) that you need help?
Lawyers are useful if the relationship has got so bad that you need to secure your legal rights. If, however, you want to avoid the cost and time expenditure involved with a lawyer (most lawsuits average a two-year timeline until they are settled), then consider getting a mediator or neutral third-party involved. They can help restore communication between the business partners so they can separate amicably – at a much lower cost too.
Whomever you ask for help, make sure they can help you achieve the following:
Some last things to think about:
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.
The same 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 of this works fine too.
If the founder is unwilling to deliver a resignation statement, it is critical to consult an attorney.
The company should also 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. Do it wisely and try to create win-win solutions that lets everyone move on amicably.
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