Co-founder relationships: How to protect your startup from a messy break-up

Last updated: 15 October 2021

Estimated reading time: 7 minutes

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Given that nearly all new companies are formed between friends or family, you’re not just risking your capital but also your personal relationships when you dive into a business venture. So, how can you prepare for potentially unpleasant co-founder relationships breaking down? This guide will help steer you in the right direction.  

Jump to:

  1. Co-founder relationships: the human factor 
  2. When and how to have the tricky conversation 
  3. Use a founders agreement to protect your business from a co-founder relationship breakdown 
  4. Founder agreements can address common problems in co-founder relationships
    1. Ownership of assets 
    2. Deadlock 
    3. Cashing in your stake 
    4. Restricting sales to outsiders 
  5. Navigating co-founder equity 

Co-founder relationships: the human factor 

Start-ups are tough by their very nature. There’s rarely enough money or time to go around and the future looks unknown. You and your co-founders are living in each other’s pockets and away from partners, family and friends. It’s no wonder that tempers can start to fray. 

What’s more, as your business starts to grow, the working environment can change quite quickly. One founder’s skills may become less important as the commercial landscape changes. A founder’s working style or personality may have been essential to get the business going, but now be an obstruction to future progress. 

An eminent couples psychotherapist has even started a podcast in which she discusses issues with co-founder relationships, in an attempt to resolve them. We recommend you have a listen, as you’ll soon come to realise that these kinds of problems are more common than you think, in fact, you can almost expect them to occur.  

It’s relatively common, in fact, for founders to leave the companies they started. However, it’s something that’s rarely discussed. Most seem to take the view that it’s something that won’t happen to them.  

However, just as in business, risks are best managed if they’re understood and discussed about before they become a reality. But these conversations can be tricky. Here are some things we recommend you think about: 

  • What are each of us going to be doing? How might this change? How much time are we each prepared to devote to it? 
  • What kind of company do we want to end up with? 
  • Are we prepared to give away shares in return for finance? How much would we each want to retain? 
  • How long do you want to be in business for? 
  • At what point might we give up? 
  • What shall we do if we fall out? Should we call in a mediator at that point? 

When and how to have the tricky conversation 

As with all relationships, the very best time to have tricky conversations is right at the beginning, when love is in the air and the future looks sunny. What’s more, to endure the intense pressure involved in running a business, you need to build your company on solid foundations, so the time to get serious about the detail (and get things down on paper) is before differences occur. 

By asking yourself hard questions about your respective co-founders’ commitments to the new venture, your short-, medium- and longer-term objectives and your vision for success, you can project likely pinch-points and differences between you.  

Projecting into the future, being open and honest about your motivations and feelings, and being ready to get to grips with the complexities of a potential founders agreement is the sensible and considered way for start-ups to set out on the road to business.  

Use a founders agreement to protect your business from a co-founder relationship breakdown 

In the unpleasant event of a break up, it will be reassuring to have formal and legally binding documents – a shareholders’ agreement in the case of a company, or an operating agreement in the case of a partnership – between you to make the path ahead clearer.  

A well drafted founders agreement – a relatively informal agreement that is the precursor to a shareholders agreement – will set the scene for a formal shareholders or partnership agreement that protects your interests, be legally enforceable, and address the needs of your business as it grows. It can cover such issues as: 

  • What happens if one of you becomes seriously ill or dies 
  • What will you do if a founder changes their personal values in a way that’s incompatible with your own 
  • What happens if one of you wants to sell their stake to a third party with whom you feel you couldn’t work 

Founder agreements can address common problems in co-founder relationships

At the beginning, when passions are fresh and movement is exciting, any formal planning for stress down the line can be seen as negative thinking – but, like any long-term relationship, considering tough times whilst you build foundations will be beneficial further down the line.   

As the venture gets more successful and the problems more complex, a range of issues can arise. Luckily, all of these matters can be explored and discussed in a founders agreement, and later, in a shareholders or partnership agreement. For example:  

Ownership of assets 

Intellectual property and assets are critical to your business. If one of the founders has registered a trade mark in their name or created a logo on a computer at a previous job, they’ll need to transfer this to the company.  

Equally, you’ll need to put directors’ service agreements and, potentially, employment contracts in place, so the terms of these can be addressed in the founders agreement.   

Deadlock 

One very common provision in shareholders agreements is that all decision-making should be by mutual agreement, and big decisions need the approval of each member of the business.  

When a business is small and easy to manage, this rarely causes problems, but as your organisation starts to grow, any dispute over its future direction could lead to a stalemate, or worse, a major dispute, unless you’ve discussed how to handle this, up front.  

Cashing in your stake 

As your company starts to grow, you may need to bring in third-party investors by giving them shares in the company. 

Imagine that you grow your start-up into a million-pound business but are unable to sell your stake because a minority shareholder (that one you haven’t heard from since the last AGM) wants to block the sale.  

A shareholders’ agreement can include ‘drag-along’ provisions that give founders the ability to force a minority shareholder to sell their stake so that the sale can proceed.  

By discussing these kinds of problems up-front, and setting out some rules in a founders agreement, you can pave the way for a shareholders agreement,  

Restricting sales to outsiders 

One of the key problems to avoid when starting a business is the failure to restrict the sale of shares to third parties. If one partner wants to cash in their stake, how can you prevent them selling their shares to a third party you don’t approve of?  An agreement can put a proper procedure in place to avoid having to deal with a potentially disruptive sale and uncooperative third party.  

Navigating co-founder equity 

In the beginning, a simple shareholders agreement with straightforward provisions will often be enough in regard to equity. It can cover the relationship between the entrepreneurs, how many shares they will own, voting rights, duties and equity contributions, and when additional shares will vest (or transfer into personal ownership).  

But once the company has begun to grow its market share and is thinking of consolidating its position, you will need to put existing and any new investors on more formal footing.  

Venture capitalists will be looking for a more complex arrangement that will translate into a new shareholders’ agreement and revised constitutional documents for the company.   

Equity can have a very real impact on culture and motivation – giving everyone that’s involved in the founding stages the chance to acquire a share in the form of an equity stake sends a message of fairness.  

In putting together a founder agreement ahead of your first shareholders agreement, consider what should happen if co-founder wants to leave, should they be allowed to sell their shares without the consent of the company at that point?  

If you agree up-front what will happen if you and your co-founders part company, you will have a better chance of avoiding a painful dispute at a sensitive time in the company’s growth.

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What next?

For more answers to commonly asked questions and advice on founders’ agreements, shareholders agreements, and other legal services for start-ups, consult our corporate solicitors. Get in touch on 0808 164 8305, email us at enquiries@hjsolicitors.co.uk, or fill out the short form below with your enquiry.

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