How to Oust a Difficult Co-founder Legally and Smoothly

Entrepreneur

17 hours ago

There are a number of reasons that a co-founder may want to part ways with another co-founder. There are also legal considerations to keep in mind when co-founders separate.
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Imagine this. Jean and John, who met at a startup incubator, founded a company together. But as they grew, Jean realized that she and John weren't aligned on many things, including what the company's future should look like. Neither John's goals nor his behavior reflected the company's mission, so Jean ousts John from the business.
Reasons for a co-founder's departure
There are a number of reasons that a co-founder may want to part ways with another co-founder.
1. Lack of dedication
A startup that wants to scale for a big exit typically requires founders who dedicate long hours for little pay (at least at the beginning). While some founders, like Jean, are willing to do that, some, like John, are not. Jean was willing to put in as many hours as it took to meet her responsibilities. John, on the other hand, arrived late and left early, demonstrating that he wasn't dedicated to his role — or the company.
2. Difficult to work with
Some founders are simply difficult to work with. They're not collaborative, they're closed off to others' input or they belittle or micromanage their employees. While in the office, John's attitude was one of superiority. He felt that certain tasks were below him and that others should do the "heavy lifting." He criticized his employees at every opportunity, lowering morale and eventually pushing a very dedicated, key employee out of the company.
3. Lack of alignment with vision
While a dream team of co-founders might be committed and great as colleagues, they might have different visions about the company's future. For example, they may disagree on a pivot other founders believe is necessary. Jean wanted to focus on R&D to ensure ongoing innovation, but John was focused on expanding the company. In addition to his behavior, this lack of alignment caused so much tension that Jean started the process of terminating her co-founder.
Related: So Your Co-Founder is Threatening to Quit Unless You Give Them More Equity. What Should You Do?
Legal considerations
In addition to mistakes that can be made during the termination process, there are several legal considerations to keep in mind when co-founders separate.
1. Complying with employment law
Founders are almost always employees by law. When terminating an employee, keep in mind — and meet — the legalities of termination, including filing certain paperwork and notices, and meeting deadlines for paying the final paycheck, for example. When the tension between Jean and John began, Jean documented each instance so she had relevant backup at the time of John's termination.
2. Is your relationship buttoned up?
Make sure you are not giving an ousted co-founder leverage. Breaking promises or not protecting the company legally in its founding documents on IP assignments or confidentiality obligations means that they now have valuable IP the company needs.
3. Do you have the legal right?
It's critical to ensure that a co-founder has the legal right to terminate another co-founder. If they do not, they should take the necessary steps to secure those rights; it might not be as simple as telling them they are fired. For example, the company's bylaws might allow a co-founder to be terminated only if the board votes to do so. The ousting founders need to make sure they can — and do — get board support.
When John's performance began to decline, Jean consulted with the company's board to ensure the board was informed from the outset.
More legal considerations: What NOT to do
While there are considerations to make so as not to run into legal issues, there are also considerations for what NOT to do.
1. Don't think about a separation agreement
A legally binding separation agreement can get you a release of claims, potentially non-disparagement terms and other benefits for the company, including agreements to not sue. Investors will want to see this if at all possible in diligence. It's worth some money to get this.
As soon as John's performance started suffering and other employees began complaining about his behavior, Jean consulted an employment attorney to prepare the paperwork necessary for a separation agreement, enabling the process to be completed without worrying about a potential lawsuit.
2. Forget to cut off access to systems
To prevent an ousted co-founder from accessing company information post-termination, ensure that they can no longer access the company's systems. Disgruntled employees with access to company data can cause major problems.
Once John was officially "out," all access to company information was cut off; Jean knew that, if given the opportunity, John would have tried to access certain data once he exited the company.
3. Bash the ousted founder to employees, investors and other stakeholders
Sometimes in trying to explain the ousted founder's departure, founders will resort to speaking negatively about them; this opens the company to defamation liability. It can also reflect badly on the company and the founding terms. Finally, it can lead to the ousted founder becoming more hostile toward the company.
Despite their differences, Jean maintained reasonable levels of professionalism. Although the process was stressful for her, her team and ultimately the company, John's ouster and the reasons behind it remained within the executive leadership team.
Related: 4 Sane Strategies for Maintaining Healthy Co-Founder Relationships
Ramifications of skirting the law
All of this advice hinges on the remaining founders meeting the requirements to legally terminate a co-founder. When they don't, there are ramifications.
1. Incurring penalties and legal claims
First, by not complying with employment laws, penalties can be incurred, and legal claims are given to the ousted founder; these can add up. For example, in California, if all wages aren't paid on the final day of employment, the ousted founder is entitled to a penalty equal to one full day of wages for every day until they are fully paid (up to 30 days).
Jean's diligence in consulting a startup attorney prepared her for the separation. In addition to the separation agreement, Jean presented John with his final paycheck at the termination meeting.
2. Post-termination negotiations
If you don't button up your relationship with the founder prior to termination, you will be stuck post-termination negotiating for what you need. At this point, you are unlikely to have much leverage.
3. No separation agreement
If you fail to get a separation agreement, investors may push on you in diligence to get one later; this is often difficult. Also, you may subject the company to claims that would have been released if money was offered as severance at the outset. Note that a founder may sign a separation agreement quickly if it's offered with a positive message and incentives. The absence of an up-front offer can result in litigation, and demands may increase.
The bottom line
While there are myriad factors that contribute to the ousting of a company founder, it behooves those on the company side to make appropriate preparations to avoid legal troubles.
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