When bringing on co-founders, set expectations properly

08/17/2014 4:43 PM

08/17/2014 5:34 PM

At the beginning everything is hot and heavy, full of passion, sleepless nights, chemistry making everything seem like it is destiny. Then something becomes annoying, or promises are broken, and the excitement starts to fizzle. A failed romance unraveling is usually a fairly easy cleanup: returning some items and looking for closure. A co-founding partnership gone awry is, at best, a big mess.

We spend a fair bit of time in our accelerator and incubator programs having discussions that could be considered marital counseling for new companies. Rarely do we find true co-partners, where they are 50-50 from day one and both invest the same amount of time, energy and expertise to make the magic happen. The biggest challenges occur in situations where there is a clear single founder who brings on a co-founder or two. In setting the expectations properly, not only in terms of ownership and decision making, but in vesting of equity, time commitments, etc., the startup will have the proper foundation to flourish while mitigating risks if a problem does arise between the partners.

I asked Daniel Eisner, co-chair of the US Private Equity Practice at DLA Piper, what issues founders need to address in bringing on co-founders. I sought him out for this specifically because DLA is the market leader in servicing firms from startup through exits. In his New York-based role, he regularly sees the repercussions of not having the right documents in place years later, when the company is worth $100 million or more and the founder has headaches in managing his or her partners in addition to going public or closing a mega-investment round.

According to Eisner, a document between the founder and any co-founders should address the following elements:

1. The role of co-founder: Most co-founders will not be jointly responsible for everything. Better to set out the parameters of the co-founders functional responsibilities up front. Failure to do so can result in unnecessary turf battles.

2. Right of termination: An employment agreement with a co-founder can reserve for the founder the right to terminate the co-founder’s employment at any time and for any reason. If not addressed, the right to hire and fire will rest with the board or CEO. If anyone other than the founder retains this right, the co-founder can always seek to sway the board’s opinion against the founder. Such agreements should require the co-founder to provide a full release to the company for all pre-termination matters.

3. Equity grant: Equity grants should be subject to vesting, which may include both time vesting and performance hurdles, as well as a share buyback right upon termination for any reason. The buyback price may be set based on lower (pro-company) or higher (pro-co-founder) price of last round or next round. The company does not benefit by allowing terminated employees to retain the value of future equity appreciation.

4. Composition of board of directors: Whether or not a co-founder has a right to sit as a member of the company’s board of directors, the co-founder can be required to enter into a shareholders agreement or proxy to allow other shareholders, including the founder, to set the composition of board of directors. Failure to do so may put the composition of the board of directors into the hands of the co-founder.

5. Restriction on transfer of shares: Whether or not a co-founder is continuing as an employee, the co-founder’s right to sell shares should be limited to sales in connection with a sale of the company or following an IPO, subject only to customary exceptions for transfers for wealth planning. Control over a company's equity capital is critical to realization of a company's long term strategic objectives.

6. Sale of company and other fundamental matters: The founder or other majority owner may retain express control over fundamental decisions, including timing and terms of a sale of the company or capital raise. The co-founder can exert influence, but should not be in a position to force fundamental actions or to bring claims if the company fails to take actions that the co-founder deems beneficial.

While the tone of these clauses may not be representative of the warm fuzziness you feel for your partner and the beautiful new startup you are bringing to life, this exercise will help keep the emotion out of decisions by documenting a shared set of expectations and roles and responsibilities to help the team withstand the thousands of other stresses and challenges that come in building a business. The fun never ends, so choose wisely.

Susan Amat is the founder and CEO of Venture Hive, an entrepreneurship education company that runs an accelerator and incubator program in downtown Miami. You can follow her on Twitter at @SusanAmat

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