Cofounder · Entrepreneurship

How would you go about buying out a cofounder?

Maria Garnier Operations Coordinator en Socialatom Group

March 14th, 2017

Things are going well on our ship, but there’s a company down the hall at our incubator which has a lot of infighting. I heard from one of my teammates (who knows someone there) that investors are pushing for two of the cofounders to buy out the third, because they all agree he is toxic. Aside from them asking him to name his price (if he would even be reasonable), what other ways could they go about buying him out?

Rob Hickling

Last updated on March 14th, 2017

Use caution in this situation.


Here's an example, in a two founder 50-50 partnership: I bought out my business partner only to discover that the project we were both so invested in was not going to be the big winner we hoped for. In our case it would have been better to just dissolve. Luckily we didn't have investors at that point which would have further complicated things.


In a three founder situation, it's obviously more complicated. My advice is for the other two founders to imagine and clearly define the company post-buy-out, and be really honest about whether it's still going to work, and whether they still want to do it. Sometimes this kind of fight can deplete your reserves and your resolve.


Either way it's a time for courage. It can be the beginning of the end, or just the end of the beginning. Good luck.



Steve Owens

March 14th, 2017

Why buy him out - just terminate him?

Henry Daas Coach-Approach Strategic Advisor

March 14th, 2017

I made the mistake of not having a buy-sell when I formed my first company 25 years ago. Never again!


Assuming they each have equal voting rights, I would consider making him a reasonable offer - ALWAYS set the ask, do not allow another to name a price! If he refuses, liquidate and reform. Naturally, seek legal council because depending on the situation, such a confrontational approach can have unintended consequences!


The best buy-sells are designed such that the buyer makes an offer. The seller then MUST either accept OR decline AND assume the role of buyer with the same terms. The original buyer is then OBLIGATED to accept. This strategy insures that the original offer is fair as the tables can be turned without recourse. Of course, even these terms aren't fool proof as toxic people tend to do toxic things...

Mike Moyer

March 14th, 2017

First, retrofit the Slicing Pie model. Slicing Pie is a universal formula for creating a fair equity split. It will tell you the right buyout price for a bootstrapped startup.


Slicing Pie will tell you what the fair equity split is. You don't have to buy him out right away, but you will be able to do a logical dilution of his equity going forward. So, if you can't afford to buy him out right now, you can wait to do it later (but before breakeven or Series A).


Trick: if he sets a price you think is too high say, "deal! We will sell you our shares for that price if that's what you think they are worth." Call his bluff. If he thinks his offer is fair, he should be willing to buy your shares at the same price.

RMD

March 15th, 2017

um... if I understood your post correctly, you are not a party to this issue. If that is correct, then you should let them figure it out on their own as, again it seems to me from your post, the source of your information is hearsay, gossip, and rumor.


That said, strictly from an intellectual curiosity point of view...


Co-founder relationships are tricky. If a "toxic" co-founder is still around, it generally means s/he is contributing to the venture in a positive way. Otherwise, as many have stated here, s/he would have been shown the door.


In some situations (such as is the case with SnapChat, for example) a co-founder made significant contributions but things weren't working out. I don't know this first hand, but from what I've read, it appears that they let him keep his vested shares and eventually bough him out as Snap became successful.


My recommendation, again, at a 30,000 foot level and without knowing any of the details, is that the company should bring in an impartial third party consultant, who is not in anyway connected to the company, and let that person mediate. At the very least, this neutral person can cut down the unnecessary noise due to high emotions.


In the past, I have used seasoned HR consultants for this kind of a task.


Bob

Joel Adams asd

March 14th, 2017

I have reminded other co-founders that they each (probably) have three roles, stockholder, Board of Directors member, and employee. It is impossible to buy out a stockholder without the stockholder's consent. The Board of directors are elected by the stockholders. CEO is hired by the board of Directors. The employees can (usually) be fired by the CEO. There may be times that an employee needs to be terminated but will remain as a stockholder. As a stockholder, that individual's rights are limited to attending the stockholder's meeting and their shares count in the vote to elect the Board members. If that individual also continues to hold a board seat, their rights are limited to their vote in the election the officers. Voting a cofounder off of the island is never easy but frequently the best thing to do. If the partners cannot agree on a stock buyout, the CEO can always terminate the employee (and change the locks). Of course, this approach does not work in a 50-50 partnership.

Peter Weiss President at American Outlook, Inc.

March 14th, 2017

The discussion/negotiation is very sensitive to the personalities. Sometimes the co-founder is relieved and willing to move on if they are treated with respect; often things get contentious.


It may be useful to break apart the economic issues vs. the control issues. if the question is how the votes will fall and will there be internal disputes, you can solve the problem with a voting agreement. If the issue is whether the co-founder should benefit from the value of the shares you need to work out a different solution.


Some advice on technique: if a third party (one of the investors?) is willing to purchase the shares the company preserves its section 1202 status which means if they get to an exit and they meet the other requirements of 1202, the owners are exempt from capital gains on the sale. I see a number of companies in a situation like this lose the exemption because 1202 does not permit redemptions of more than a token number of shares.

Rob Kornblum

March 14th, 2017

I'm not sure why there is a need to buy him out.


All employees, including founders, serve the board and the board can terminate them. The co-founder would leave with whatever stock he had vested plus any more that he would be entitled to per his founder agreement.


However, he may be so toxic that that want his stock too and don't want him as a minority shareholder. This is where is gets complicated. Unless there is a provision in the founder agreement, buying his stock will need to be done at fair market value to avoid setting an artificially high value for the common stock. He may not want to sell at that value. But if the investors pay up, then they have set a high price for the common stock and will impact the value of future options and possibly future preferred stock sales as well.

Paul Benedetto Many time entrepreneur, advisor and financial guy

March 14th, 2017

Let's assume that each co-founder was granted some level of equity in the company and that it is fully vested. I suggest the purchasing group come up with an opening offer instead of asking for the soon to be exiting partner to "name their price." Coming up with an amount that has some economic thought behind it gives a stronger basis for negotiation and may help move the process along while tempering the various emotions between the parties.


If you already have investors on board, I would look to the last round of financing to provide a base valuation. I think it would be then up to the person being bought out to negotiate any higher amount - say if there has been further progress on re-risking the business.


In a perfect world, questions on hypothetical founder exits would be contemplated at the point of a business being started, with a both a process and calcuation framework memorialized within legal documents (e.g. LLC operating agreement, corporate bylaws) - basically a prenuptial for your business.


I've seen both pre and post revenue formats of the above implemented at various startups. Each has worked well with providing transparency between founders and helped reduce the potential for litigation situations - saving the company time, stress and money.