The co-founder ‘pre-nup’ - why every business needs a breakup plan

Much like any relationship, co-founders start their journey together full of optimism and excitement for the future. Falling out is far from their minds. But, with research showing that as many as 65% of promising startups fail because of founder disputes, smart founders should put a plan in place to deal with disputes.

Embrace conflict and don’t idealise avoidance

Co-founders fall out for hundreds of reasons - from basic disagreements to unequal shared equity or a co-founder leaving to pursue another project. But being aware of the common causes and how to avoid them can help in the long run, especially as most startups take a 'deal with it later' approach, rather than a 'better safe than sorry' one.

Co-founders can lose compatibility. This can come in many forms, one of which occurs when co-founders go from being companions to competitors. As is often the case when people collaborate closely on very intense projects for long periods, there’s a fine line between working together smoothly and the relationship becoming fraught with conflict. In some circumstances, this leads to both parties becoming precious about their own position in the company and exactly what they have ownership of.

We once advised a co-founder of a technology startup that hadn’t put a shareholders’ agreement in place. Although the business was initially successful, when things took a turn for the worst the lack of clarity caused by the absence of any legal terms created all kinds of problems and was extremely costly.

If the relationship becomes bitter on a personal level in this way, the co-founders are often faced with a 'fight or flight' situation where they either continue down a path of toxicity full of confrontation and disagreement, or decide to avoid the situation (and sometimes each other) altogether. However, this kind of avoidance is potentially more detrimental to the business - if issues aren’t talked through or addressed, they often pile up and become something bigger and less rectifiable later.

In conflicting relationships, it’s difficult to keep professionalism and personal perspectives separate, especially when it’s a family or close friends’ business. However, even though avoidance may seem the easier option, it’s potentially more devastating in the long run. 

Putting a plan in place

Being prepared - that is, having a co-founder ‘pre-nup’ (usually referred to as a shareholders’ agreement) in place - by nature requires the co-founders to discuss having a potential dispute in the early days of the business.

There are a number of pragmatic ways to have an effective plan in place. Once the initial topic has been flagged - and, it’s always better for it to have been done in business terms, openly and professionally - the next steps are discussing what needs to be done and why it’s important to each individual.

Specifically, it can be useful for both parties to document what each expects from the setup, ideally during the first 12 months of the company’s existence (i.e. before undertaking any significant funding round) and certainly before or as soon as the company is regularly engaging in any material commercial activities, the co-founders should have their lawyers draft a basic shareholders’ agreement.

The lawyers engaged to prepare the agreement should be able to provide a short set of questions detailing areas the agreement will cover, so the co-founders know what to think about and are able to decide on the initial terms.

Typically, a shareholders’ agreement should include important information beneficial to the interests of both sides, including: how equity will be shared, IP ownership, pre-emption on issues of new shares/transfers of existing shares, restrictive covenant (or 'non-compete') obligations, leaver provisions (i.e. what happens to the equity if a cofounder quits), a structure for how decisions will be made (including board appointment rights and any matters on which co-founders have a veto) and deadlock provisions (sometimes containing a buy-out mechanism if there is an irreconcilable disagreement).

Remedying a deteriorating relationship

Ultimately, disputes - whether they’re about the brand of coffee you order in or who has economic ownership of the company - are part of business. When they do arise, addressing and confronting them is almost always more effective than ignoring or avoiding the issue. But when a dispute becomes something serious that is impeding the running of the business and which both co-founders are unsure of how to rectify, it can be extremely difficult to see any option other than litigation.

However, before it reaches that stage - co-founders needn’t fear asking for help. Seeking professional advice from a lawyer or an independent member of the board, such as an experienced non-executive director or even an independent opinion from someone with relevant expertise who is trusted and respected by all parties, can help get to the root of the issue and identify actionable, practical solutions to get the relationship - and business - back onto the right track.

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Kemp Little

Kemp Little is a technology and digital media law firm.

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    Richard Kemp
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