By David Ehrenberg
Choosing a startup cofounder is difficult enough (I offer some tips in a previous post here). Now imagine the implications of that person leaving. Do you know how to handle a cofounder's sudden (or not so sudden) exit? Specifically, what decisions and steps should you take to safeguard the value of your business and maintain your focus in the aftermath?
Founders exit for a variety of reasons. But the nature and timing of an exit has a big impact on you and your business. Three kinds include:
- An unexpected exit: Whether due to illness, death or a better offer, this kind of exit is probably the hardest to deal with because it usually arises with very little warning.
- An exit due to conflict: All too commonly, the relationship between cofounders comes under serious strain. It could be because of a misalignment of values and vision; maybe you differ on how to scale your business or whether to take on new investors. In this case, minimize the potential for disaster by ending the collaboration. Of course, if you can’t agree on how to run the business, be prepared for difficulty agreeing on an exit.
- A negotiated exit: When it’s clear things aren’t working out -- whether it be with performance issues, the need for a different skill set, or after the type of prolonged conflict I mentioned above -- one or both of you might decide the best option is to buy out the other and sever the business relationship. This is probably the most clear-cut situation to deal with in the sense that you’re both on the same page.
If you know an exit is on the horizon, here are five immediate courses of action you should take:
- Activate your contingency plan. Depending on the reason for the exit, your “key man” insurance policy might help cover it. It’s a critical piece of a good contingency plan, and investors often require it. Next, come up with a plan for divvying up your cofounder’s responsibilities, at least on a short term basis, to cover the transition period while you figure out how you’d like to move forward.
- Get legal advice. Make sure you protect your IP by going through an off-boarding process that includes the departing cofounder returning proprietary information, signing non-solicitation agreements, and acknowledging his or her obligation not to divulge confidential information. Consult a lawyer to make sure you’ve covered all issues and ask for advice to minimize the risk of legal disputes arising later.
- Negotiate. Timing, transition, how to handle ownership stakes, valuation, IP, and in some cases, the kind of continuing relationship -- whether as an equity owner, a consultant, or an informal advisor -- are some of the major areas you need to agree on. While you might turn to trusted advisors for guidance (and if you have a formal board, it will definitely be involved), don’t make this a do-it-yourself enterprise. Have a lawyer negotiate and draft any binding agreements.
- Address equity ownership and transfer. The last thing you want is someone without a vested interest in the company’s success leaving with a good chunk of equity and a say in the business. If your founders agreement doesn’t provide for a vesting schedule, if your cofounder is already fully vested, or if (gasp!) you don’t have an agreement or vesting policy, you’ll need to come up with funds to buy your cofounder out. Focus on figuring out the smoothest way to recover the shares, whether that be through a buyback, accelerated vesting, or some other arrangement.
- Reach out to investors and creditors. Being open and transparent is the best way to minimize downside risk and shore up investor support. And let’s face it: you could very well be in a situation where you need to delay agreed upon timelines or need more funds sooner than planned. Be proactive in communicating what’s happening and why with your investors. Give them an idea of your plan for keeping the company on track and assure them you will safeguard their investment.
- Review your business plan. Consider the financial and strategic implications, including whether and how the business will continue without your cofounder.
If you have dealt with a cofounder's exit yourself, what else would you add to this list?
David Ehrenberg (@EarlyGrowthFS) is the founder and CEO of Early Growth Financial Services, an outsourced financial services firm that provides early-stage companies with day-to-day transactional accounting, CFO service, tax, and valuation services and support.
