Founders · Equity

How do you tactfully and fairly push a co-founder out?

Trevor Collins Crowdfunding Entrepreneur & Co-Founder of 100 Danish

July 10th, 2014

I was hoping to get guidance on a situation a fellow entrepreneur friend is going through. I’m not personally going through this, but getting feedback for her would be incredibly great. And could be instructive others.

Here’s the deal:

My friend founded a company with another entrepreneur and they divided up equity in a 40%, 40% split. The remaining 20% is designated for other potential founders and advisors. It seems in the bylaws of the company, both he and her have to come to a consensus on major decisions. In other words, there is a large probability of a stalemate if they disagree on something big.

Turns out, the guy she is co-founding with is making operations of the company impossible. He is not completing work, getting emotional and irrational during decision-making, and is generally abrasive towards another potential co-founder.

So she has come to the point where she would like to come to some sort of terms where he gracefully exits the company. Or takes a backseat role as an advisor. She has been thinking of an arrangement where he could retain a small percentage (~5%) and the $100k he has personally invested could convert to some sort of note with a return. She also has invested money herself, around $50k. And she has deep experience in the space and will be the key driver of the company.

She mentioned to me a few things:

  • He is an older and experienced guy who has a valuable Rolodex to make introductions from
  • She still thinks he could occasionally give pertinent advice regarding the company
  • She was hoping to emphasize that she feels the company cannot be launched and grow with him still a part of the core team
  • They are super close to launching their first version of the site, which will be fully functional and polished
  • She is convicted on the business concept and believes it could be something great, and wants to do the right thing with the co-founder

How might she best proceed in a meeting with him? What might be fair terms in this case?

As a founder, you’re always in fundraising mode (whether active or passive). In this course, we’ll teach you how to successfully raise follow-on capital, establish a valuation for your company, build an investor pipeline for your next round, and more.

Robert Clegg

July 10th, 2014

Sounds like all you have to do is bring in another investor for $1 and you control the voting. Of course that's an exaggeration, but it highlights the fact that to solve this problem may only be one of investment poker. Bring in the money, hold a vote, establish a CEO, board, etc.

Second, and this is more for the community out there - Get new lawyers. What firm on earth advises equal voting with no board control so decisions can be made? You've been extremely poorly advised.

Third, the lawyers represent the company, not individuals. You should have your own representation. Do you and the other founder have employment agreements with the company? Have you assigned all intellectual property over to the company? If not you may leave and start up your own.

Fourth - I know you are deep in the weeds on this. But take a long view. If you are really an entrepreneur this won't be your only "idea". Stop thinking of this as "your baby".  Breath, let it go. Then look at this as a learning experience for the next venture you will be in down the road. Let go of "ownership" and value the experience. What can you gain from somehow moving this venture forward even if it means losing control? Would you give up control if your other founder bought you out for $X,000? Or invested $X,000 to become CEO and on the board? What if he raises more money in the scenario above?

I speak from personal experience. I had a $1M deal on the table at one point in my early career. I blew it up and walked away because I was losing control of the company in the first round. I wasn't able to handle what I thought was kind of a hostile takeover from the guy I was working with - even though he brought in the money! I was immature. Looking back, my career would have benefited greatly by moving forward even though it was not an ideal situation. 

I since launched another venture, went through $12M in venture funding and STILL saw things that weren't "ideal" happening to my control of the company and ownership. 

Take a long view and see how you feel.

Best,
-Robert


Kate Hiscox

July 10th, 2014

How was the funding handled? Did he purchase equity? If he believes in the business he should take a step back but getting him to go to 5% from 40% will be very difficult I imagine without her diluting too in order to free up equity. Do they have vesting agreements with for cause conditions?

Paul O'Brien

July 10th, 2014

Jason and Kate have the right idea as frankly, what you are exploring is rather difficult but can be accomplished at a change in the financial status of the company.  Many startup entrepreneurs don't fully realize that there is a difference between starting a business with partners, and a company.   In the first case, the "co-founders" are truly owners and as a business partnership, that ownership amount is unlikely to ever change.  You probably aren't raising equity based capital in that case so the cap table doesn't adjust to account for those investors (instead you're taking on debt or other forms of investment to capitalize the business).

As a venture backed company, every funding event gracefully enables a change in the cap table because the valuation of the business changes.  The most obvious way in which this changes is that investors come in with some amount of money and effectively BUY ownership; your 40/40/20 has to adjust to accommodate that ownership.  Your actual # of shares may remain the same, decrease, or increase; actual # of shares is not the same as the % change.  When an investor comes in and buys a percentage (and the respective # of shares), everything else must change - how is up for discussion and always negotiable regardless of the terms set forth previously (the terms previously agreed to can always be changed, by way of consensus or legally if need be).  Say you have a new investor that is going to get 10% of the company, you could change the % ownership to be 30/40/20/10 where the first co-founder loses percentage by not gaining more shares during this round; the other founder and the 20% would be allocated more shares to retain their % in the new structure.

I'm WAY oversimplifying but the point is that if the founders agree, you do this by bringing in investment.  Forget what they've invested previously (time and money) as that's irrelevant.  That's an emotional consideration that doesn't apply practically.  The ownership is 40/40/20 now.  Period.  At the time of an investment, the company is revalued and at that point, Cofounder 1 agreed to become an advisor and adjust their ownership % to 5%.  To do that, shares have to be allocated/reallocated elsewhere in accordance with the investment and the % ownership the remaining cofounder will retain.  Important to keep in mind: Cofounder 1 still in a sense OWNS what they owned previously!  At the former stage, they owned 40% which, for the sake of argument was 100,000 shares.  At this new stage, they still own 100,000 shares which WAS 40% but because of the changes in the business, they are diluted as agreed going forward given the new valuation, their ongoing role, etc.

It's a tough situation emotionally but it's not tough when you think like a company which is, what I presume, you intend to build.  In that case, it's all math; it's ALL fair but you do have to have the conversation with him and help him understand and agree.  The challenge is that he's emotionally invested because it's what "he built" but the reality is that as a company, it's not what he built, he owned 40% of what it was; going forward it's something bigger and he still owns a VALUE consistent with what he had in the previous state, relative to that new value.

Jason Oliver Founder and Technology & Product Executive

July 10th, 2014

Tough situation. I really don't think you can take away his agreed upon ownership. If she could get him to agree to not be an employee and just an advisor and sign over some percentage of voting rights of his stock. Then he'll get diluted like everyone else and she can additional stock later to offset the current distribution. 

Daniel Marques Director of Application Development at Pragma Securities LLC

July 10th, 2014


Given the disparity in how much each invested for the same stake, it seems like there must be some other terms to their agreement.


I think a good course of action would be to meet with the other founder, discuss how the relationship has become dysfunctional and then see if some sort of consensus could be met.  Maybe it is too early, but maybe this could be solved by bringing in a CEO?


Of course, we're only hearing one side of the story.

Taylor Dondich Vice President of Engineering at MaxCDN

July 10th, 2014

Consult your corporate lawyer.  Did you have items in writing that described situations like this? Was the equity based on a vesting schedule? If you don't have any of these items, you're going to have a strongly difficult time removing this person, especially with the equal ownership split.

This is generally just more support for Kate's answer above, so I'm voting for that, however, re-iterating here (vote for hers).

Dimitry Rotstein Founder at Miranor

July 10th, 2014

Unfortunately, I have a personal experience with this sort of thing, and I'm afraid there is no graceful way of figuring out a graceful ending after the fact. This is why it's important to include vesting and termination conditions into the founders agreement right from the start (these are the most important parts of the agreement). It's not clear from the description whether there was any vesting at all in this case. As for equal split, it was bound to cause problems - it's impossible to decide everything in advance, because the startup business is unpredictable. One popular solution is to get an arbiter to resolve conflicts. Actually, there is a small chance that it's not too late to find a third person to try and settle the argument, either by mitigating the conflict and allow the team to go on, or to decide how to end it. That's the best I can come up with.

Ryan Nurmela Managing Director at bigCampus, Inc.

July 10th, 2014

Get out as soon as possible. It only gets worse from here. Operations will always go through ups and downs, so don't be lulled into complacency, thinking that the problem is solving itself or improving. All deals you could have brokered near term will worsen over time. The deal you offered sounds fair and well thought out. Because you both have money involved and not a lot of product, it's going to be tense. Engage a lawyer if needed, but now that you've reached this point, be resolute and act fast.

Trevor Collins Crowdfunding Entrepreneur & Co-Founder of 100 Danish

July 10th, 2014

I talked to my friend and she was able to clarify some great points:
  • The vesting schedule is a 1yr cliff at the end of 2014. It's a 5yr total schedule.
  • The cash that she and him put into the company is not tied to equity, just a loan to the company. Also, she will eventually be matching his $100k.
  • If he agreed to it, she could buy out his shares as per a repurchase right. If he agrees..
It's tough because she can't technically outvote him. Apparently he's been pushed out of a company he co-founded before and that was what motivated him to push for the equal voting rights. He also wants the role of CEO but isn't actually able to step up and fill it.

Peter Morgan CEO at Zepto Ventures

July 10th, 2014

Tough call - he has put more money in and owns 40% equal share of stock. Odds are actually in his favor at this point.