Co-founder disputes: minimising damage

Fallings out between founders is sadly quite common among start-ups. What is just as frustrating is where there is no prior agreement on how to break the deadlock and move on – often with the result that continuing founders have to buy out other founders for cash, at a price they can’t refuse, at the worst possible time.

Here’s a pattern I often see:

• One or more original founders create the concept and ‘hack’ together a working prototype
• Original founders are told by external mentors (quite properly) that they need further co-founders with complementary (often technical) skills
• Original founders feel under pressure to give second stage co-founders a similar shareholding to their own – crucially, free of any of the normal restrictions on employee-owned shares that allow deadlocks to be broken and shares to be clawed back
• Second stage co-founders often don’t share the same vision or passion as the original founders, and lose their sense of commitment when the business hits inevitable obstacles
• Original founders have to lean on friends and family to raise money to buy out second stage founders, at a time when cash is particularly tight.

A better approach might be for original founders to be less generous as to who is treated as a founder, or at least who receives unrestricted shares.

There is no reason why second stage founders need to be given unrestricted shares. If second stage founders are included in a normal employee share scheme:

• Mechanisms to break deadlocks (through reduced voting rights) and claw back employee shares will already be built in
• There may be significant tax advantages for second stage founders and the company to use a normal employee share scheme
• A second stage founder can still be given the ‘feel good factor’ of founder status through job title and labelling of the employee share scheme, without the business-destroying risks of giving out significant holdings of unrestricted shares.

RM2 has significant experience helping start up companies designing employee share plans that produce a positive outcome for second stage founders, while protecting the status of the original founders of the business. If you’d like to talk about your position, in confidence and without commitment, call to speak to one of our advisers on 0208 949 5522.