Navigating Founder Separations in Venture-Backed Companies
Founder conflicts and separations present delicate challenges for venture-backed companies, particularly in contexts where fundraising has become difficult or valuations are being challenged. This article discusses relevant factors in successfully resolving founder disputes.
Defining a founder dispute
A founder dispute refers to a situation in which disagreement between two or more founders escalates to (i) legal claims being made between a founder and another founder, or a founder and the company; or (ii) paralysis in company decision-making and governance, such that key business or legal decisions can no longer be made.
In the case where founders are making direct legal claims, informal settlements can often be reached through the swift intervention of experienced business advisors (such as independent directors or a key investor) or through company counsel. In the case of paralysis, investors or independent directors may be wary of choosing sides, particularly in the absence of clear mismanagement. Such “soft disputes” can often linger for months or even years, imposing silent but real costs on the company.
A lack of alignment between company founders can kill company momentum, ruin internal morale, and threaten the investment as a whole. In the context of insolvency, additional considerations come into play, particularly the need to consider creditors as part of directors' fiduciary obligations under applicable law. Founders may inadvertently ignore such obligations if they are too focused on the dispute, raising the prospect of derivative claims brought by a major creditor.
Common resolution frameworks
The following are common resolution frameworks that can help address a founder dispute, depending on the circumstances:
Restructuring — The founders can agree to a restructuring of roles and responsibilities, for example, a founder stepping off the board or a change in corporate officer responsibilities. This can be accompanied by changes in compensation, including equity compensation. Restructuring is often the least painful and most efficient way to resolve a dispute in which the relationship is still salvageable between the founders.
Buyout — In circumstances where differences are irreconcilable yet remain professional, a founder could be bought out from the company and depart entirely. The terms of such a buyout can vary depending on the circumstances (e.g., a release can be obtained or consideration may be paid to the departing founder). Equity re-allocation discussions will oftentimes be sensitive.
Termination — In certain circumstances, a company can terminate a founder if the company’s board of directors approves the termination and if the founder’s service agreement sets forth clear terms for such termination. Termination can be complex and emotional and should not be undertaken lightly. A key friction point in termination scenarios is the treatment of unvested equity. Founders often have 'Single Trigger' or 'Double Trigger' acceleration clauses in restricted stock purchase agreements. Terminating a founder 'For Cause' to avoid acceleration is a high-risk legal strategy that can easily lead to litigation. A negotiated transition is almost always cheaper than a litigated termination. However, termination may be appropriate particularly when the company is concerned about a founder’s conduct or if there are genuine legal claims against the founder and it is necessary to protect company trade secrets and proprietary information immediately from further access.
Resolving the Dispute
Sometimes, an experienced business advisor such as an independent director or major investor can help broker a deal. Company counsel can also help informally mediate a solution, with the important understanding that company counsel’s fiduciary obligation is to the company and not to any particular founder. If there are concerns about needing a fully independent or neutral party, strategic dispute counsel or a mediator can also be brought in to resolve and restructure relevant relationships.
A founder separation does not have to be the end of the company. Properly managed, it can even be seen as an important restructuring event that sets the foundation for new investment and future growth. The goal is not just to resolve the dispute, but to position the ongoing entity for continued success.
