Thinking About the End at Incorporation is Central to Resolving Founder Breakups but is not the Only Consideration
Every month, thousands of new companies are launched in the U.S. Many of these startups are founded by people who have pre-existing relationships, such as repeat co-founders, friends, or former colleagues. However, sometimes a fresh idea and shared passion for solving a problem among recent acquaintances may launch a journey to deliver a new product to a target market awaiting a solution to a known pain point.
Entrepreneurship is tough and can be quite lonely, even when working within a formidable team. Navigating rocky terrain with friends is tough; doing so with relative strangers can be even more daunting. The stresses of the known and unknown can lead to disagreements and different perspectives about previously shared aims. Some reconcile, and some tolerate one another in pursuit of their common destination. Other times, however, founders opt to go their separate ways instead of finding opportunities between their opposing views.
The breakup of a founding team can be a complex and emotionally charged event. Since founders usually wear several hats, distinguishing between the distinct roles requires intellectual and emotional acuity that is often abandoned during the disagreement.
When founders of a startup are also stockholders and members of the company’s board of directors, the legal considerations become even more intricate. Equally important, each person’s tie to being a “founder” give rise to emotional and psychological considerations that are not often captured in any of the legal documents.
In this blog, we will discuss the key issues that should be considered when navigating a founder breakup and explain why the way founders document the terms of the relationship at incorporation plays an outsized role in the tools available to resolve the breakup.
THE LEGAL AGREEMENTS AND STATE LAWS DRIVE THE LEGAL ANALYSIS.
The first consideration is the company’s governing documents, such as the certificate of incorporation, bylaws, and stock purchase agreements. These documents typically outline the procedures for removing a director and officer of the company, as well as the rights of the company and the departing founder. The stock purchase agreement should also spell out the company’s right to repurchase unvested (and, in some cases, the vested) shares of the departing founder. It is important for legal counsel to review these documents carefully and ensure that all parties understand their obligations and rights under them.
The company’s governing documents should be prepared in compliance with applicable state laws. If the governing documents do not provide clear guidance on how to handle a founder breakup (principally, director and officer removal and stockholder rights), the next step is to review applicable state laws. In some states, for example, there may be default rules governing the removal of directors. It is essential to understand applicable state laws and how they apply to the specific situation at hand.
Another important consideration is the impact of the breakup on the company’s operations and finances. It may be necessary to negotiate a separation agreement that addresses issues such as severance, founder status, stock ownership, non-compete, non-solicitation, non-disparagement, intellectual property, and the payment of any outstanding debts and obligations.
When a founder breakup occurs, it is also essential to consider the impact on the company’s employees, customers, and investors.
The departure of a founder can have a significant impact on morale and may result in key personnel leaving the company. To mitigate any potential harm to the company’s reputation and operations, it is crucial to communicate openly and transparently with stakeholders.
Finally, it is important to consider the potential for litigation. In some cases, a founder may dispute the terms of their departure or claim that their rights have been violated. It is essential to have a clear understanding of the legal risks involved and to take steps to mitigate them, such as obtaining legal advice and drafting a comprehensive separation agreement.
In conclusion, when a founder breakup occurs in a startup where the founders are also stockholders and members of the board of directors, it is crucial to carefully consider the range of legal and business issues at hand. By taking a proactive and strategic approach, it is possible to minimize the negative impact on the company and its stakeholders, while also protecting the rights and interests of all parties involved. The most prudent approach involves discussing a potential breakup when drafting the company’s governing documents and founder agreements, a discussion that might include founder vesting, repurchase rights, non-officer roles within the company, and previously unknown considerations discovered during negotiations.
Even with the proper documents in place, the company and founders would be wise to consult with experienced startup counsel to navigate the separation. While the governing documents and applicable state laws might clearly establish each party’s rights, the appropriate solution might require resolving the legal matters and the emotional considerations.
Experienced counsel should be skilled in both areas. After all, convincing a founder that it’s best for them to walk away from their life’s work has never been easy.
