Entrepreneurs face many threats that can affect the timing and the success of their businesses. The most obvious threats are external ones – the economy, changes in regulations that directly affect your industry, the threat of competition, or worse yet, someone stealing your ideas. For this reason, most entrepreneurs that come to me for the first time are looking to protect themselves from external threats – a standard non-disclosure agreement, a trademark or patent filing – as it is generally believed that having NDAs in place and IP pending approvals demonstrates the company has created value and is protecting it diligently.
But consider this: most investors would cite as the most compelling reason they invest in a company is the management team yet, strangely enough, these relationships are usually the least protected of all the company’s assets.
According to the National Venture Capital Association, you and your partner will have a falling out within a month of working together and it is commonly known that 9 out of 10 startups fail within the first 2 years. (as per Forbes Invest In Startups, if You Dare, to Balance Your Portfolio, Sept. 21, 2012).
Over the years, I’ve been asked to intervene on a variety of disputes – worst of which include: one Founder emptying out bank accounts, changing office locks or another taking company equipment to use as negotiation leverage. Fortunately, there are laws to deal with these situations but no one really wants to go there when starting up a new business.
A Founders Agreement is akin to a prenuptial agreement for startups. Without them, points of contention with respect to management responsibilities, share ownership, terminating of employees (or co–founders), contract details, and personal investments can disintegrate great partnerships.
In spite of precautions – NDAs, trademarks, privacy and disclaimer statements, the founders of my Start up didn’t have any formal agreement that addressed the issue of termination (or break-up of the Founders). We simply assumed we’d address these critical issues at the time of funding (a/k/a let the investor decide).
So clearly, a Co-Founder falling out on the eve of signing a Term Sheet with an Investor is probably the worst thing any entrepreneur could imagine. Yet, this is exactly what happened.
After many months of investor presentations and continuing to personally bootstrap the company, my partner lost faith and patience. So instead of shaking hands and parting ways, unbeknownst to me, he began to circumvent our business relationships for his own personal gain. He began contacting a couple of my longstanding clients to handle their business directly. I had just gotten off a phone call with a trusted colleague advising me of this offensive behavior, when a fax came in from an investor I had previously met, setting forth terms of a very attractive offer to fund our company.
The following day I was scheduled to speak at a conference. Afterwards, a banquet was planned and there sat the traitor wearing a name badge with my company’s name. He was smiling and had no idea I knew of the wrong he had done our little company.
As I looked over at his goofy, crooked toothed-smile I felt my blood pressure rise. I wish I could remember the exact words that set this Entrepreneur into a psycho tailspin but all I can recall is reaching down for the Crème Brulee at my place setting and without so much as a blink, dumping it directly over his head. Seeing his look of astonishment (and the startled expressions of those who witnessed this display of assault).
There was no way we were going to resolve our co-founder disputes.
So that left me with 2 choices:
- Fight him in court to enforce the NDA (putting company business on hold and likely losing the investor);
- Make him a buyout offer and move on.
I decided to be candid with our investor about our falling out (which, by the way is always good business practice). Turns out, not only were they willing to invest, but they also agreed to buyout his shares.
(On principle, the lawyer in me really wanted to take him to court but the CEO in me had to be commercial and do what was best for the company and the rest of the staff. All in all, was not an easy pill to swallow).
The take away from all this:
A Founders Agreement is the single most important thing to do up front. The first year is make it or break it so– set yourself up for success by promoting a culture of clear communication. Otherwise, disputes can often lead to litigation or otherwise, as in my case, tossing Crème Brulee.
Want to read more about Startup Agreements? Here is a blog I like from Simeon Simeonov that talks in more detail about Founders roles and agreements. I also like this book The Founder’s Dilemmas: Anticipating and Avoiding the Pitfalls That Can Sink a Startup (Princeton University Press, 2012).
Thanks for stopping by!