Surviving the Strife: How Start-Up Founders Can Ensure That Inevitable Friction and Departures Won't Sink the Company

by Bryan Cave Leighton Paisner
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History is all too often repeated when start-up founders fail to plan for when (not if) they don’t see eye-to-eye.  Relationship breakdowns and messy founder departures are common root causes of start-up failures.  Common sense steps taken in advance can help start-ups navigate through the inevitable times of strife.

Distinguish Between Founder and Very Important Persons
Start-ups frequently suffer from “too many ‘founders’ syndrome.”  More “founders” means more opportunities for intractable problems to threaten the company’s existence.  So differentiate founders and “very important persons”.  Every person involved in a startup’s early stage is not necessarily a “founder”.  That title often creates expectations of life-time tenure, equal percentage ownership rights, say-so, and unwarranted job title expectations – each hazardous to the company’s existence as discussed below.  Very important persons are just that – very important, but not irreplaceable.  Very important persons can be provided equity ownership (typically out of a stock option program) but at percentage levels that are market-driven and sensible to their true capabilities and contributions.

Discuss Roles and Responsibilities Early and Frankly
The emotional rush of a start-up’s early days can cause founders to gloss over the reality that they have disparate personalities and competencies. Start-ups typically begin as egalitarian ecospheres where all founders are equals, wear multiple hats and make all decisions by consensus. And no one is truly in charge. Eventually, process stagnation and friction will impair any ability to make decisions that are critical to framing and executing growth plans. Clashes are inevitable but don’t have to grind operations to a halt. A person overseeing early marketing and sales efforts should not expect a life-time appointment as VP of Worldwide Sales. Nor does a team of three founders acting by consensus later become three “Co-CEOs”.

Therefore, at the outset, founders should discuss their expectations about roles and responsibilities. Ensure all founders are prepared at some point to be replaced in their operational roles as the company’s needs evolve. A founder who refuses to recognize his or her natural limitations as the enterprise grows in size and complexity is likely to become disgruntled enough to threaten the company’s very existence when they must be forced out.

Similarly, institute early a traditional hierarchical structure so that decisions are made, direction is set and stuff gets done. Consensus building will still have a place, but everyone should be prepared for a decision-making authority paradigm.

Divide the Equity Pie by Merit, Not Numbers of Founders

Not every founder necessarily brings equal value, worth or critical assets to the table.  Therefore, don’t automatically divide the initial equity pie in equal pieces.  A founder who is important to developing initial software architecture that, if needed, can be outsourced to a development shop is not necessarily entitled to the same percentage ownership as a founder who contributes the all-important cash or know-how from prior successful start-ups.  Moreover, as a start-up evolves, some founders will become more central than other founders to the company’s future success.  When venture capital investors conduct due diligence and review a start-up’s cap table, they will want to ensure that the relative equity ownership percentages properly motivate those who are key to the company’s continued growth.  Discuss ownership percentage expectations early and allocate equity in a thoughtful manner that truly reflects the founders’ contributions and merit.

Plan for the Wayward and Walkaway Founder
The more “founders” a start-up has, the more likely it will experience early departures, whether involuntarily or involuntarily. Plan for them.

First, put vesting agreements in place so that if a founder leaves for any reason during an agreed time period, the company can recapture some portion of his or her equity interests. A common vesting schedule for founders is equal monthly vesting over two to four years. In some cases, an immediate vesting of some portion of equity interests is merited where founders have been engaged with the company for a long enough period (e.g., more than one or two years). Not only is this good planning for the founders who stick around, having a vesting program in place sends a good signal to potential investors that none of the founders are opposed in principal to vesting of their shares.

Second, avoid guaranteed employment contracts where a founder can be removed only for “cause”, typically described as various intentional bad acts such as theft. “Cause” can also include repeated failure to perform ones duties after notice and an opportunity to cure the failure. However, a “failure to perform” standard is inherently subjective and therefore difficult to prove absent costly and lengthy litigation. If a founder is making valuable contributions and pulling his or her own weight, there is little need for them to worry about being terminated willy-nilly. If they are not, however, it is imperative for the company to be able to replace that founder with someone having the necessary skills. And the company will need to have equity available to attract the replacement. Therefore, avoid providing founders with such no-cut employment contracts. Founders will naturally be concerned that they are vulnerable to termination without any good reason if they are in the vesting period for their founder shares. That is a legitimate concern and best addressed in their vesting agreements. Typically, if a founder is terminated without cause, they should vest in some portion of their unvested shares.

Third, avoid costly termination costs like sizeable guaranteed severance payments that make it too costly for a cash-strapped company to utilize. In theory, it may make sense to terminate a founder who is disruptive or simply ineffective. But if terminating that founder will require a 12-month severance payment, the cost alone may make it impractical to do so.

Summary 

Founders should plan for inevitable friction.  While some friction is normal in personal relationships, in start-ups it can lead to more catastrophic results.  Common sense planning, including taking steps like those outlined above, can help founders survive the strife.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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