How startups can survive co-founder issues
Mon 19 February 2018 - 4:26 pmStartup | Tips | Advice
Recently, Matt Berriman – the co-founder of fast-growth adtech startup Unlockd – wrote an open letter explaining why he was stepping aside as CEO.
This shone the media spotlight on the intensity of co-founding a fast-growth company and started a valuable conversation about issues and solutions. This article discusses how to lay strong legal foundations for co-founding, with a shareholders agreement that addresses co-founder disputes, underperformance, resignation, disability and death.
Unlockd has had six successful capital raises/exits over eight years and grown into a global company with 55 staff in five countries and annual recurring revenue of $20m. This is phenomenal growth and requires extraordinary time and effort.
Berrimman stepped aside in the best interests of the company and his own mental health. I was grateful for his courage and candor in discussing this publicly. If we expect that all co-founding teams work successfully together until a company sale, retirement or death, then we have unrealistic expectations.
If we have realistic expectations – for example, that the intensity of co-founding may not be for everyone and this may be apparent quickly, or that a co-founding relationship may work well for several years then need change – then we can implement solutions that are in the best interests of the company, for long-term sustainability and success.
In Australia, it is common that co-founders are issued with shares in the company in early days, in consideration for their work in the company as employees and often as directors. What if a co-founder is unable to continue, soon after those shares are issued? What if the relationship works well for years, then cannot continue? Worst case scenarios for a company include a co-founder’s early departure with a significant number of shares, a co-founder failing to perform, animosity, disputes, and long disruptive negotiations.
One of the best solutions is a well-drafted shareholders agreement with (i) share vesting, (ii) leaver clauses, (ii) events of default clauses and (iv) dispute resolution provisions. The goal is that whatever situation arises, there is solution in the shareholders agreement to solve the issue and help the company survive.
Share vesting has the effect that the co-founders earn their shares over time. Common vesting provisions are four-year vesting, being 25% after the first year, then the shares vesting quarterly after that, over the next three years.
If the co-founder is a ‘good leaver’, it is common for the co-founder to retain the shares that they have earned and forfeit the rest. Good leaver departure includes no-fault departure such as death, permanent incapacity, retirement or redundancy.
Bad leaver and event of default
If a co-founder is a ‘bad leaver’ or commits an event of default, it is common for the co-founder to have to offer the shares they have earned, for sale (to the company, the other founders or all other shareholders) and forfeit the rest. The sale price is usually a discount to the fair market value, e.g. a 20% discount.
Bad leaver events include resignation (usually within a set period e.g. the first year) or termination of their role due to fraud, an indictable criminal offence, breach of a restrictive covenant or a material breach of the employment or consulting agreement.
Events of default include a material breach of the shareholders agreement, serious misconduct, fraud, and bad leaver events.
A well-drafted shareholders agreement includes clear dispute resolution provisions. The usual process is for one party to provide a dispute notice setting out the issue and proposed solutions. Then senior executives or managers who have authority to resolve the dispute meet. If the dispute cannot be resolved, the parties must go to mediation through a well-recognised process such as the Australian Commercial Disputes Centre or by a mediation appointed by the relevant Law Society.
It is in the company’s best interests to plan solutions for co-founder issues. A well-drafted shareholders agreement is an important investment. It requires the co-founders to consider expectations and commitments and sets out fair solutions that work. It provides a way for a company to withstand co-founder issues and continue on for long-term success.
About the author
Ursula Hogben is a co-founder and Practice Leader at LegalVision, a multi-award winning legal startup. Ursula has over 15 years’ experience in corporate law and investment banking in Asia, the United States and Australia. She provides commercial arrangements for launch and growth including advising on structuring, intellectual property protection, hiring, scaling and capital raising.