How Not to Get Written Out of Your Founder Story
Nearly 50% of founders are removed from the position of CEO within the first 18 months of receiving funding. Those are daunting odds—so what are the best ways to prevent this from happening to you?
Attorney Teela Smith is one of three partners at Smith Shapourian Mignano, a law firm that focuses on startup law and small businesses. She says that it's key to be proactive about setting expectations up front. "Most often what we see when things go south, it's just there wasn't a lot of communication or foresight. A lot of early-stage founders, they have a dream, and they're excited about it, and they want to bring on board everyone who's helped them realize that dream."
Crystallizing this communication around a formalized structure is also crucial. "I think it would be irresponsible to start a company and not come up with the agreement on who owns how much and how will that work," says Andy Sparks, the former co-founder of Holloway and Mattermark, who is now a coach to startup leaders. "Do you own it all at day one? Or do you vest it over time?" Sparks adds that he "deeply recommends" doing the latter, since building in flexibility leaves room for personnel changes as life or career situations evolve.
Who knows what happens a year and a half into the company? Maybe priorities shift where something else becomes more important. You can't predict that."
In addition to sorting out operational matters, he stresses that delegating specific roles and responsibilities—such as who's going to serve as CEO—also makes it easier for founders to hold each other accountable. "A lot of founders won't have those conversations up front, out of some sort of misplaced sense of generosity," Sparks says. "But what ends up happening is that there's no real leader of the ship. And so then no one can hold the leader accountable. And that's where bickering and arguments come in."
The specific scope of these positions is another major area where establishing expectations is key. When co-founders don't clarify important benchmarks—for example, how many hours a week each person should be spending on the startup—disagreements often follow. "What if someone quits their full-time job and devotes himself entirely to this, but someone else has a different financial situation and they really need to keep working full time and they do this in their off hours?" Smith notes. "Things like that just need to be communicated from the outset because that's what's most likely to lead to conflict, at least in the first couple years."
Get everything in writing
Along these same lines, startup founders also need to be sure to follow applicable employment laws as they pertain to their own positions. Smith describes a scenario where a pair of co-founders with slightly unequal ownership (say, 60% and 40%) initially don't pay themselves salaries because the startup is bootstrapped. If, a few years down the line, an argument leads to the founder with more equity trying to jettison their partner, it could lead to catastrophe.
"Suddenly that person who's upset is going to come back and say, 'Well, guess what? You haven't been paying me the applicable wage under the employment laws for two years now. I'm hiring an attorney, and I'm going to hit the company with the lawsuit,'" she says. "Even as a co-founder, you are an employee of the company, and you need to treat your other co-founders and employees according to the law, because otherwise there's going to be a lot of leverage to take things down if a dispute arises."
In this case, having a written contract is certainly key, Smith adds. "I would recommend that co-founders, even at the early stages, have a formal offer letter or employment agreement of some sort with the company, or a co-founder agreement that talks about, 'Hey, what happens if I get fired from my company? Is there severance due? Is there some acceleration of equity?'
Negotiate those things from the outset, so expectations are clear and if that does come to pass, there's no uncertainty about what might happen."
The offer letter's severance clause should outline what someone is entitled to, if let go without good cause, whether that's financial remuneration or acceleration of unvested equity. For founders, this also adds some safeguards. "That can give you some security that you won't just be terminated or removed easily," Smith says. "There will have to be a lot of thought that goes into that. And if things aren't working out, it impels some good faith attempts on the company side to negotiate with you and try and resolve things before just cutting ties or making a rash decision."
Clarify the roles of investors & advisors
When it comes to giving away equity, founders should stick to written agreements—and be judicious about who's awarded a stake. "I think it's a big mistake when anything is handed out freely," Smith says, noting that industry standard for advisors, for example, typically would be .25% to 2%, vesting every 24 months. "You want to make sure that if you're getting advice from someone, and they only offer you two months of advice, they don't walk away with 2% equity in your company. Maybe that doesn't seem like a lot at the beginning. But when you're talking about years down the road, it's millions of dollars, and it's a big deal."
When vetting investors, co-founders might not always have as much control, Sparks says. However, establishing "a foundation of trust" with both co-founders and investors early on can go a long way to mitigate problems. "A lot of founders will make this call to just take the investor's money without really vetting the investors," he says. "And then they find out that the investor’s idea for where they're going is different from theirs. That's where you can get yourself in a lot of trouble."
Smith echoes Sparks' observation. "When you go through an investment round, and now you have an investor who owns a significant voting percentage of your company, [they] probably have a board seat and exercise some control," she says. "A lot of times that investor will say, 'Hey, we've got some dead weight here. We need to bring in a new CTO. You can work on projects with the head of engineering, but we really need someone else here.' That can be tough for a founder to deal with."
At the end of the day, keeping the lines of communication open can help co-founders protect their valuable business and assets. "At every stage, it's important to renegotiate the terms of your relationship with the company—from the outset with your co-founders, and then once you go through an investment round," Smith says. "[Make] sure that you negotiate with your investors in advance about what the salaries will be, what sort of severance and termination rights you'll have, any upping of your equity percentage. Things like that should be renegotiated at every stage."
By laying a groundwork based on trust, transparency, and communication, founders can grow with their company—and be part of future success.