Don’t have a Founder’s Agreement? How to Break-up without Hating Each Other

Summary:  It happens, we all make mistakes.  Despite what is “common knowledge”, you started a company with a friend without a Founder’s agreement.  It happens all of the time.  Remember that your relationships and reputation are most important.  Then go find standard Founder’s agreements and “negotiate” a graceful breakup as if you had one from the start.  

Here me discuss this on SoundCloud

During my startup help office hours entrepreneurs often approach me with a dilemma:

“We’re breaking up AND we don’t have a founder’s agreement. How should we divide up the equity/cash, etc.”

Rather than wag a finger at them and chastise them for what they SHOULD have done – as a lot of references on this topic seem to do – I try to offer constructive suggestions about what to do.

Keep it Real – The Stock is Probably Worthless

Your Reputation & Relationships Matter the Most

This is a really, really hard thing you’re going through. Super emotional. After pouring months into the dream of working with a friend you’ve realized that you don’t have the perfect partner. Tensions are high, feelings are hurt.

So before you start negotiating … take a step back and think about the long term.

The odds are near 0% that the stock will be worth anything.

The odds are also near 100% that how you break up – your professionalism, sense of fairness – will influence your long-term relationship and your personal reputation.

You. Your Reputation. Word will spread – trust me.

Think long and hard about burning friendships or saying things you can’t take back. Think about the next Angel investor who calls your previous co-founder – yes, investors do this. Think about how much better you’ll both sleep if you take the next steps with a sense of fairness.

Do you really want to haggle and make enemies over 0.5% of something that is probably worth nothing?

Basic Strategy: What if You had an Agreement?

Negotiate your breakup as if you had a Founder’s Agreement

You’re fair.  Your co-founder is fair.  You both started a company in good faith.The basic strategy is to enter the “negotiation” as if you had started the company with a founder’s agreement.

That’s it. Roll back the clock and execute the breakup as if you had a founder’s agreement in place.

Just Google around and find one or two that most closely match your situation and use them. For instance, the Y-combinator documents.

Then do your best to workout the details quickly and fairly – remembering all the while what matters most.

Equity Vesting: Keep it Simple

Forget the Cliffs, Accelerating, etc.

Most founder’s agreements suggest 4-year vesting with a 1-year cliff.

First off, skip the cliff. You don’t want someone hanging on for another 5 months taking up a desk just to vest. Cliffs are only fair for everyone if they are known in advance. Consider it a cheap education for the remaining founder(s).

While there is no such thing as a “standard” agreement, this will serve as a starting point for our purposes.

50/50 founders would each vest 25%/2 = 12.5% after a year, or about 1%/month. So a founder that decided to leave after 7 months would get 7% of the equity.

Of course your situation may not fit so neatly into this situation. Perhaps one founder started earlier or worked a lot more on the startup. I suggest making a minor judgment call such as:

“Well, if we had 4-year vesting I would get 7%, but since you started a bit earlier and worked a bit longer, how about we go with 5% just to make things easy?”

IP – Check out a Standard Employee Agreement

But be realistic about what you would have negotiated

See the Y-combinator docs. For the most part, the company owns what you both built while you were there.

You Both Put in Cash? Talk to the Accountant

Treat it like an “Owner Loan”

Cash can get more complex since it is obviously worth “something”. I’m assuming there is still some $$ left in the company bank account, that you’re building a software company (i.e. your time was a much bigger contribution), and that you contributed roughly the same amount.

The easiest and fairest way to deal with cash is through your accountant. Hopefully you have an “owner loan” account to handle the cash; if not, have your accountant create one based on contributions and ask them to suggest a fair way to pay back the founders based on what’s left in the bank.

Of course you’ll have to leave a few months of runway for the company and the company will most likely owe the departing partner some money.

How do other startups deal with cash?  Ask around, then ask your accountant to execute on it.

Still Stuck? – I’m NOT a Lawyer – Get One

But first try to come to a common agreement

You can always schedule time with me and I’ll try to help you as an unbiased third-party.

I’m assuming you haven’t raised money from 3rd parties, you’re leaving on reasonable terms, and that one of you isn’t a thief or a scam artist.

Barring that, if your situation is complex and more is at stake I suggest talking to a lawyer.

Of course you’re still better off coming to a mutual agreement in advance – otherwise you’ll be spending your time and money paying lawyer fees. Ouch.

One Comment

  1. Gari Nickson March 2, 2013 at 1:50 pm #

    Great article Kevin! Thanks for sharing. Really enjoying your posts and sound cloud clips ;) Keep it up!

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