How Founders (Should) Break Up

posted in Ethics, Formation, Founders on by

Nutshell: There are two ways for founders to break up. One preserves everything those founders built together, including a chance of a successful outcome. The other can bring everything crashing down, ruining months, even years, of hard work, and damaging lives in the process. Simple decisions made at the beginning of the relationship dramatically influence which outcome you end up with.

Worthwhile reading:

First off, like any good lawyer, let’s get our definitions straight. I’m talking about Founders (capital F) in this post – meaning the people who were there at the beginning of a startup, or at least well before it became something investors wanted to buy a part of. For better or for worse (probably worse), the term “founder” has become just another title that gets negotiated by early hires to help artificially build their street cred. If you showed up to a startup with your own lawyer, or with data on compensation packages, you’ve gone through very different dynamics from actual founders.

The Honeymoon Period – Setting the Foundation.

Know and trust each other. 

It sounds sappy, but it’s unquestionably true: starting a startup with a cofounder is about as close (emotionally) to starting a family with a spouse as you’ll ever get, without actually starting a family with a spouse. CEOs refer to their startups as “their baby,” and they’re not kidding.

You have to go in totally trusting the other person, and committed to the good of the startup as something separate and higher than your own self-interest. If you don’t, you’re demented and asking for a world of pain.  I look at our portfolio of startup clients, and the vast majority (but not all) of the top ones were started by either (i) two or more cofounders who are real friends, or (ii) a single founder with total control. In each case, minimal time is spent arguing over equity %s or vesting schedules. It doesn’t mean everything is lollipops and sunshine, but everyone knows their role. Founders who are mere ‘business partners’ generally underperform compared to founders with a strong, personal relationship.

Paper it.

Different people have different approaches to marriage. Some are big on prenups, and others aren’t. But for founders, sign some damn contracts. Standard ones that shouldn’t take startup lawyers very long to produce. They should have:

  • Clear language regarding the Company’s ownership of all IP;
  • A vesting schedule (~4 yrs), with a cliff (~1 year);
  • Non-solicits and (depending on the state, but def. if you’re in TX) non-competes;
  • Language about returning all company property on termination; and
  • No ambiguity as to what happens if/when a founder leaves voluntarily or involuntarily.

I’ve often heard founders say something like “we don’t have VCs yet, so we don’t need vesting schedules.” Totally wrong reasoning.  The vesting schedule is there to ensure that if someone walks away before a meaningful milestone (especially if they walk away angry), they can’t take with them any chance of the Company’s ever succeeding.  Try raising VC money with 40% of your cap table held by an inactive founder.   The cliff serves a similar purpose – it puts in black ink what everyone should already understand: this is a long-term project, and if you’re not in it for the long-term, you shouldn’t be signing up.

Papering this kind of arrangement among a good group of founders should not be controversial.  If I start seeing founders bickering over vesting schedules, or random contingencies in their founder docs, my views on their long-term prospects are automatically dropped several notches.  I’m also not a fan of founders negotiating “single trigger acceleration” among themselves – “if you fire me, I get X% of my vesting schedule accelerated”.  If you’ve chosen the right founders, no one should be getting fired unless it’s the right decision for the startup. And if it’s the right decision for the startup, you shouldn’t be walking away with more than what you actually earned.

When the Honeymoon’s Over – A Clean Break.

I’ve said it before, and it’s worth repeating: Contracts Aren’t for the Honeymoon; They’re for the Divorce.  While there are hundreds of reasons why a founder might break away from a startup, if the proper foundation was set, there should be minimal legal ambiguity as to what happens to the startup when that founder is gone.  IP stays, as do all unvested shares. The departing founder keeps what she vested. Deliver everything to the company relating to the startup – hardware, code, login credentials (which should be changed after the departure), etc. Don’t try to take any employees with you, or build a competing product. Move on.  

A simple letter stating the definitive termination date should be delivered by the Company to the departing founder, spelling out what the post-termination equity holdings will be, and delivering the small amount of money needed to repurchase the unvested shares.  It’s also often considered a best practice to give a departing founder a small “sweetener” – a few extra shares, or a little cash, in exchange for signing a full waiver and release of all claims, including a non-disparagement clause (you can’t start insulting everyone on twitter).  Hopefully there aren’t any real claims to waive, but when VCs diligence the company and see an exit of a major founder, it gives them a bit of comfort to see that release signed.  Founder lawsuits have a way of creeping up once a few zeros are added to the valuation.

Emergency Maneuvers.

Not everyone is so lucky to have a clean founder breakup.  Sometimes angry founders refuse to return company property, or refuse to sign documentation relating to their departure.  I’ve even seen situations in which founders are caught maliciously hacking into servers.  Prepare yourself.

If the proper legal foundation was set early on, a refusal to sign anything shouldn’t be a serious problem. Good founder docs are drafted so that simply e-mailing a termination notice, along with a check, gets everything material done. Signatures on termination docs is nice, but not essential. As to other things like refusing to return property, usually the first step is to have some personal conversations about how small startup ecosystems are, and that reputations take a long time to rebuild. A nastygram from your corporate lawyers can help too.  If all that fails, it may be time to get other lawyers (litigators), or other authorities, involved. Hopefully it never gets there.

But if you didn’t do what you were supposed to do when the founders first got together, and now you have an angry, defiant founder who perhaps still owns rights to company IP, or has walked away with half the cap table… well, you fu**ed up. Is this the end of your company? Not necessarily, but it definitely could be. Talk to your lawyers. Maybe there’s enough of an e-mail trail making it clear that IP was intended to be transferred. Maybe a recapitalization (a ‘recap’) is possible to wipe out everyone’s equity and start fresh. Maybe you can eventually convince them to sign the right docs now.  Maybe. Regardless of the outcome, you’re going to be paying your lawyers a lot more (like 20-100x) to clean it up than you would’ve paid to do it right on day one.

Only idiots start families with people they don’t trust, or truly understand. Founders who start companies with people they don’t trust, or who think it’s unnecessary to paper things properly, aren’t much smarter. Find the right cofounder, and then sign some damn contracts. Then hope you never have to read them again, and start building.

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