What Happens If Your Co-Founder Wants To Leave The Company?
You and your co-founder spent months, if not years, building your company. You worked side-by-side (or perhaps remotely) for more hours than you care to count, and you both made significant contributions that you can directly attribute to the business’s current position in the market. You were both committed to doing whatever it took to succeed; but, now, your co-founder wants to leave. In fact, he or she is requesting a buyout from the company.
What do you do?
The departure of a co-founder can be a complicated situation even under the best of circumstances. In an ideal scenario, the company will have documentation in place that clearly prescribes the mechanisms and procedures for buying out a founding owner. But, even when this is the case, startups will often lack the liquidity required to complete a buyout outright. When the company’s documentation is inadequate (or non-existent), there are even more questions that must be answered to everyone’s satisfaction in order to avoid a costly (and potentially business-ending) dispute.
Key Questions When a Co-Founder Demands a Buyout
Are You on the Same Page?
One of the first, and potentially most important, questions is: Are you and your co-founder on the same page? In other words, are you on good terms, and are you prepared to have him or her exit the company? If the split is amicable, you stand a far better chance of negotiating a mutually agreeable buyout that protects your company’s critical assets and maintains its current trajectory.
If you do not want your co-founder to leave — whether because you believe he or she is critical to the business’s future or you do not want the company to take the financial hit from a buyout — you could be facing a tricky situation. Likewise, if you and your co-founder are fed up with one another and he or she wants to bleed the company for as much money as possible, the split could become contentious (not to mention costly). The terms of your Shareholder Agreement and other governing documents will be critical, and you need to understand their implications sooner rather than later.
What Governing Documents and Agreements Do You Have in Place?
When you and your co-founder formed the company, what documentation did you put in place? Do you have a Shareholder Agreement and bylaws (or Operating Agreement if you formed a limited liability company)? If so, what does it say about buyouts? Is your co-founder entitled to demand one? On what terms? How is the company as a whole, and his or her ownership interest, to be valued? Does selling his or her shares necessarily mean loss of management and control rights as well? Or, will this need to be addressed separately?
If your co-founder started working on your product before you formed the company, did he or she sign an Intellectual Property (IP) and Technology Assignment Agreement? If not, any IP assets (such as trademarks, inventions, software code, and media content) that your co-founder created prior to the company’s formation may be his or hers to keep. Is he or she willing to give them up? If so, at what price? Does the agreement address post-formation IP creation as well? These can be sticky issues that can lead to very real business viability concerns for remaining founders.
As a related issue, is your co-founder subject to confidentiality and non-competition covenants under the terms of any of your governing documents or agreements? If not, is he or she planning to leave and start a competing business? What rights (if any) do you have to prevent that from happening?
Has Your Co-Founder’s Stock (or Membership Interest) Vested?
In some circumstances, co-founders may choose to include vesting provisions in their Shareholder and Membership Agreements. Under these provisions, the company retains the right to buy back all or some of the founders’ respective ownership interests until a certain event or point in time. If your co-founder’s shares have not vested (i.e., the event or point in time has not yet been reached), the terms of the buyout should be fairly straightforward and your co-founder’s leverage should be minimal.
How Will Your Company Fund the Buyout?
Maybe your startup has the cash on hand to buyout your co-founder’s shares. If so, great, you are in a better financial position than most startups out there. But, if you do not (or if you do not want to deplete your company’s cash reserves), your company will need to look for alternate sources of funding to complete the buyout.
What options are there? Finding a new partner is one possibility. Your new partner could either buy your co-founder’s shares outright, or he or she could make a capital contribution (in exchange for the issuance of new shares), which the company then uses to pay your co-founder. Seeking outside investment is another option (assuming the timing is right); but here, too, there are several important legal considerations involved. You could also look into debt funding, either from a financial institution, from you, or from family and friends.
Do You Want to Consider Purchasing the Shares Instead?
Depending upon the circumstances at hand, it may also be worth considering whether you want to buy your co-founder’s shares instead of effectuating a buyback through your corporation or LLC. Why might you want to consider this? Lack of capital within the company is one reason, but tax implications, your goals with regard to securing outside investment, and numerous other factors could potentially weigh in favor of you buying out your co-founder as well. Of course, this is not a decision to be taken lightly; as with all of the issues discussed in this article, you will want to review your options with an experienced attorney.
Is Your Co-Founder Willing (or Obligated) to Sign a Release?
When the buyout is complete and your co-founder has left the business, you want to be confident that the split is completely clean — in other words, there are no loose ends that could lead to your former co-founder filing a claim against the company. The primary tool for protecting your company in this situation is a Release Agreement.
Why would your co-founder be willing to sign a release? You (or, technically speaking, the company) may have the leverage to demand a release if your co-founder does not have a clear right to force a buyout at his or her desired valuation. Your Shareholder Agreement or Operating Agreement could also require a release (or include a self-executing release) as a condition of buying back a co-founder’s shares. Note, however, that your co-founder may also seek a release and indemnification from the company to avoid the risk of personal liability in the event that your company gets sued down the line.
Speak with Attorney Jiah Kim About Your Co-Founder’s Buyout Request
As you can see, there is no single, straightforward solution to addressing a co-founder’s desire to leave. If your co-founder has requested a buyout, the first step toward understanding your options is to undertake a careful review of all of the governing documents and agreements that your company has in place. For more information, and to get legal advice custom-tailored to your unique personal and business circumstances, call (646) 389–5065 or schedule a consultation with attorney Jiah Kim online today.
This blog post is written for educational and general information purposes only, and does not constitute specific legal advice. You understand that there is no attorney-client relationship between you and the blog publisher. This blog should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.
Originally published at jiahkimlaw.com on May 12, 2017.