Corporate Law

3 Ways To Legally Avoid Co-founder Conflicts

Written by Team Farallon | January 24, 2018

At the start, things seem rosy. A few people come together with a brilliant idea to start a business that will change the world or, at the very least, disrupt an industry. The plan was to introduce something groundbreaking, hopefully, make a fortune, and then ride off into the sunset.

But the reality is that many startups and businesses are derailed by disputes and conflicts between founders and business partners.

Why this happens

For startups, conflicts typically arise when a company has its first taste of success (e.g. attaining a certain number of subscribers or achieving a revenue target). Once this happens, they may have vastly divergent views on how to proceed and on the future strategic direction of the company.

For more mature companies, on the other hand, conflicts typically arise when business partners have differing goals with respect to their personal lives and how this relates to the company. For example, a business partner may want to retire while the others still want to proceed. In this case, the issue would be how the business partner may exit and cash out his or her stake in the company without disrupting or compromising the business for the other partners.

Mitigating the risks

Strategy document

To mitigate the risk of conflict in terms of differences in company direction and strategy, founders and business partners should discuss and agree upon the future direction and strategy of the company in detail from the very outset. This should be set out in a strategy document which can be updated periodically as and when strategic plans change.

For added rigor and formality, founders can consider holding regular founders’ meetings where company strategy is part of the agenda.

Shareholders’ agreement

To mitigate the possibility of a power struggle and exit risks, founders should have a carefully drafted shareholders’ agreement in place.

The shareholders’ agreement regulates the relationship between the founders (as shareholders) of the company. It contains provisions dealing with critical issues such as company management (for example, who is to be appointed to the board of the company) and how important company decisions (such as any future fundraising, the purchase of major company assets, or the hiring/firing of key personnel) are to be made.

There are also numerous permutations as to how company decisions may be made. Decisions may be at the board or shareholder level and may be decided upon via a show of hands, a simple majority vote, or by poll. To mitigate the risks of future conflict, founders need to carefully consider how each of these are structured, taking into account the number of founders, the role of each founder, and their shareholding stake in the company.

In our experience, the risks of conflict may be greatly reduced by making a decision at the outset as to who is in charge. Decision-making structures where authority is equally divided among two or more parties increase the risk of a decision deadlock.

The shareholders’ agreement should also contain a well-crafted dispute resolution clause with clearly set out stages of escalation and explicitly spelled out conditions and timeframes for escalation. For example, in the first instance, conflicts may be resolved by “amicable” discussion between the conflicting parties, where one party may give the other notice that he or she would like to initiate such a discussion. There should be a time constraint for such discussions (e.g. four weeks from the date of the initial notice).

If the conflict remains unresolved, the final stage is usually for the dispute to be referred to the courts.

As mentioned above, another benefit of having a well-crafted shareholders’ agreement is that exit scenarios are clearly spelled out. This reduces the possibility of a conflict arising as to how to deal with the exiting founder’s shares in the company.

Employment agreements

Having employment agreements in place for key personnel would also reduce the risk of a conflict between founders. A founder or shareholder of a company may also be an employee of the company if he or she is expected to perform a defined role and is responsible for certain tasks.

An employment agreement should clearly delineate the role that each founder (as an employee) is responsible for. This would reduce the likelihood of conflict occurring as a result of ambiguity as to each founder’s role within the company. In the event that the role changes or a founder subsequently decides to exit the company, the employment agreement may be updated to reflect the new role or terminated.

Under an employment agreement, a founder may also receive additional compensation (salary or other benefits) for contributions to the company. Each founder’s salary could be adjusted periodically to account for differing contributions to the company. This is another way of reducing the likelihood of conflict, as you properly recognize and compensate each founder for their respective contributions.

Conclusion

Founders and business partners ought to realise that conflicts are very possible and take a cold-hearted look at it from the outset. The suggestions we have provided above are aimed at reducing the possibility of such conflicts happening in the first place. In the event that such a conflict does occur, these steps will reduce the time, cost, and potential emotional toll of resolving them.