Do you have founders leaving the startup? It is an unfortunate truth but very often the team that first embarks on a startup concept is not the same team to finish. For a number of reasons one or more founders decide to leave or are pushed out.
Departing founders can be a large problem down the road. The two biggest concerns when a founder departs are ownership and intellectual property (“IP”). Again, this just emphasizes why it is so important to properly form your company. See our blog post on Founders Agreements for more insight.
Unfortunately, there are no easy answers. The four most common situations faced by startups formed as corporations are listed below. There are similar but different procedures to undertake when you are a LLC which are akin to a partnership dissolution (do not worry, we will get to this!) The potential solutions below revolve around correcting the mistakes made during formation. In almost every situation the solution requires some amount of cooperation by the departing founder. If that does not exist, however, more legal actions may be necessary – maybe even folding the company.
This blog post has been prepared at the direction of several employment & corporate attorneys but it is an area that has not been fleshed out well by the legal community. We hope to do that here over time. You guessed it – these documents are coming! Consult an attorney before making any final decisions.
1. Everything Was Setup Correctly (Vesting & IP Assignment)
As it should be, life is easy when things are done right the first time. When vesting is put in place and IP assignment is solid then a departing founder should not present much of a problem from a legal standpoint. Generally, companies will choose to exercise their repurchase option and purchase the founder’s shares which have not vested – this is the point of a vesting provision in a founder agreement. At a minimum, a company would need to create and execute:
- Board Minutes acknowledging a) that the founder is departing, b) the company desires to repurchase the shares under the repurchase option, and c) the company is solvent and has the ability to repurchase the shares; and
- Notice (usually written) to the founder that the company is exercising their Repurchase Right accompanied by a check for the aggregate price of the stock. See our Founders Stock Purchase Agreement for a DE Corporation to see an example of this notice and repurchase agreement (Exhibit A in agreement).
Want to leave the founder with a little something for his efforts (~ 1-2%) if none of their stock has vested? A properly written Founder Stock Purchase Agreement allows the company to repurchase “all” OR “some” of the total restricted stock from the departing founder. You will need to issue the departing founder a new stock certificate with the appropriate legends and make a record in the Board minutes.
2. Company Was Formed, Stock Was Sold But There Was No Vesting Put Into Place
The departing founder is under no obligation to sell his stock back to the company when there is no vesting in place. Therefore, the ability to get the stock back is circumstantial. If you are lucky and the departing founder is cooperation then, at a minimum, the company will need to create and execute:
- Board Minutes acknowledging a) that the founder is departing, b) the company desires to repurchase the shares, and c) the company is solvent and has the ability to repurchase the shares; and
- Stock Repurchase Agreement (signed the by departing founder).
Again, if you want to leave a little something for the departing founder then do not repurchase the entire lot. You will need to issue them a new stock certificate with the appropriate legends and make a record in the Board minutes.
3. Company Was Formed, Stock Was Sold But No IP Was Assigned
Attorney Ryan Roberts talks about the importance of locking down IP at every turn in an early startup. Again, most of the time the departing founder is under no obligation to assign his IP to the company if some kind of IP assignment agreement was not already put into place. Therefore, the ability to get the IP into the company is again circumstantial. If the departing founder does not want to play ball then they do not have to.
There is another catch. The transaction must have new consideration, which typically translates into having to pay cash for the IP. This is all up for negotiation – it could be $1 or $1000. At a minimum, this will require the company to create and execute:
- Board Minutes acknowledging a) that the founder is departing, and b) the company desires to purchase IP; and
- IP Assignment Agreement (signed by the departing founder).
4. Company Was Not Formed Correctly: No Stock Was Sold And No IP Agreement Put Into Place
Sometimes, founders do not properly form a company – neglecting to put in place ownership, management, bylaws, etc. The resulting default entity is a simple partnership. A departing partner can take whatever they put into the the partnership. At this point, the biggest concern is IP if the departing founder possess any IP valuable to the company. The method below is just one way of solving this problem.
- Properly form your company (create ownership, establish bylaws, etc.). See How to Form Your Delaware Corporation or How To For Your S-Corporation for reference.
- IP Assignment Agreement (signed by the departing founder) (see above regarding required additional consideration).
Some General Thoughts On Release Agreements
A release agreement is an agreement between a company and a departing employee which relieves the company from a great deal of liability resulting from the employment. We hear it mentioned often as a possible remedy for departing founders. There is one problem with a release agreement – it requires separate “adequate” consideration such as a severance package – not common in most boot-strapped startups. Courts have found that release agreements supported by nominal payments are unenforceable. One can certainly try to get a release agreement signed, but do not be under any illusions that it is the end-all-be-all – other more important issues like IP must be handled.
Again, having a founder leave is very difficult because of the intersecting legal issues. Consult an attorney before making any final decisions but make sure the attorney has dealt with these matters before and understands the issues.
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This blog is reposted from the Upcounsel Blog, where it first appeared on February 26, 2012.