co-founderI am part of a company with 4 co-founders. Before we incorporated, we had an MOU, that we created on Google Docs and signed. In that MOU it noted that when the company incorporates, this MOU would be dissolved. The MOU stipulated that between the 4 co-founders, we each own 25% of the company.
We then incorporated and in the articles of incorporation we are each listed as First Directors. No other provisions listed or details about split.
We have not yet done a founders agreement (e.g. vesting schedule, roles and responsibilities), no share purchase agreement, no other legal documents yet.
One of the co-founders has not been pulling their weight for months and is not taking feedback. We called a vote and got 3/4 for him to exit.
The person that got voted out agreed to leave but not without equity. He has spoken to a lawyer and that lawyer has advised him that the MOU plus articles of incorporation and the work he has done to date means he has a case for equity.
The exiting co-founder has offered to go down to 10% equity, undilutable and that he can sell it back to us at fair market value or to future investors. He has also offered 20% of profit each year be given to him in perpetuity and no equity.
Both options are unattractive to us.
The three remaining co-founders (which includes myself) believe he should get 1/4 of current company profits as exit compensation. We also believe that the MOU is no longer in effect and that articles of incorporation are not substantial enough to demonstrate equity split.
We will be engaging a lawyer some more but I wanted to get the community’s thoughts on this matter…thanks!
Update:
Thanks for all your comments to date. A couple things about this MOU: 1) It references a company name that we did not incorporate with (e.g. it reference ABC Co. but we incorporated as XYZ Co.) Does that matter? 2) It also has a line that states the MOU is to be dissolved when the company incorporates. Therefore, is that MOU even valid? That is the only document that talks about equal share splitting
sounds like a tough situation, but unfortunately all too common.
The terms that they are proposing for their exit of the company sound extreme and are likely to kill your start up or severely limit your ability to raise investment (if that is in your future plans). An investor would be extremely wary in putting money into a put where there is an undiluted 10% giving no benefit to the business and 20% of the profits going out of the window.
10% undiluted is ridiculous, you’d be issuing them with new shares when you raised another round in order to stop them being diluted.
You need to cut them out of the business, they cannot be allowed to maintain undiluted equity or suck money out of the business without putting anything back in.
My counter and best offer would be 10% which would be sold back to the company at the next round of investment - i.e. they get a windfall for their prior services and are no longer part of the business, or if they wish to maintain their equity then they must give part of their time to the company as an employee or consultant.
Make it clear that if they are not adding future and continued benefit then they cannot expect future and continued rewards. That the 3 of you won’t get the same kind of deal until you all exit the business and would have to continue to work in order to maintain their benefit which is unfair on all of you.
First, get a lawyer. Second, get a lawyer.
You made a very common mistake when you split up equity without putting requirements for each of you on earning the equity. Equity should never be a gift, it should be exchanged for a concrete contribution to the enterprise, whether capital (cash or equipment) or sweat (the famous sweat equity).
You probably can’t easily undo the decision, and you want to minimize future liabilities that hang over your business (you sell to Google for $100M, he sues). Regardless of what name you give the entity if he worked on it he’s going to have some sort of claim given the MOU. Following is my advice, and again, before doing anything I recommend review with your lawyer as not just legal, but reasonable, and ask them specifically about what potential liabilities that you will still be exposed to on any path you take.
Create a shareholders agreement to set the initial share count for the company, and give everyone their 25% equity as agreed to in exchange for the work they’ve performed to date. And with no restrictions on dilution, put together company documents giving the board rights to issues employee incentive shares, issues shares in exchange for funding, etc. He can agree to this or not, but it’s reasonable and has less liability than trying to force an entirely new and different agreement on him.
Then at your next board meeting, have the three active founders/board members vote to establish an incentive pool of shares for contributions going forward, and give each of the active founders a stock option grant for further shares. Based on what you want to accomplish you can make the incentive pool as big as you want, it could be equal to original founding share count (in which he will be diluted down to 12.5% when all options vest), or even higher.
Note: By creating an incentive pool and tying it to employment over time, you are also avoiding having this happen a second time if another founder leaves.
What may tie your hand is valuation. If you value the company based on nothing other than sweat equity and are pre-product launch, valuation is in the eye of the beholder. You can likely argue that additional years of sweat equity should be valued the same as the first year. But if you already have revenues, customers or an offer to buy the business for $10M, diluting his equity by large amounts starts to be much harder if not impossible. This is a reason to get your ducks in a row now, as soon as possible.
And one last note. You should explore doing your incentive options as restricted stock grants instead of ISOs. This way you and the other two active founders own them from the beginning, can vote the shares, and get long term capital gains if you sell the business in a year. The “restricted” part means if you leave before the end of your vesting you will forfeit some of the shares back to the company.
Otherwise ISOs (incentive stock options) can’t be voted until you vest them AND purchase them, which means you have to come up with money to get your own shares. They also have some nasty tax side-affects and you can really easily end up paying much higher tax rates. Apple uses Restricted Stock grants, ask your lawyer about whether you can, at least for the founder’s incentive plan
I have studied business administration and this is my generic idea of the situation, but I must say that I am not a lawyer and I may be totally wrong.
4 people founded a company and are shareholders, they signed a contract where they split the shares between them self.
Shareholder can not be fired (but he can be fired as director). Actually about the Director roles, If you are familiar with big corporation director represent the shareholders, so your 3 director will operate with 75% of the shareholders votes, while him, will operate like minority with the only role of controlling that you will not take advantage of this situation by hiding profits and writing fake Accounting Data.
There is one way to actually fire him.
You three majority shareholders can make a capital increase, that will depreciate his shares (like Mark did in “Social Network” with Eduardo) This subject is very delicate and it is indeed useful having a lawyer if the start up has some potential. My opinion is that if an investor comes in to make a big capital increase he has 2 options:
a. Sell the shares
b. Get his shares depreciated I am not sure about the legal aspects.
You three majority shareholders can grant yourself a salary for the work you are doing with your company, while he may not be able to do it, because you can vote against it (but i am not sure). The problem is that that would be a waste of money for the additional taxes that you will pay on the salary, while dividends have a lower taxation.
I would avoid the lawyers, as to me it makes no sense trying to exploit somebody from his own shares, if you wrote an agreement that clearly stated it and signed it, but this depends also on the amount of money at stake etc..
Anyway if he has 25% of the shares he should get 25% of dividends every year.
My final advice is avoid lawyers, if you just signed a contract with him, technically he does not have any right until he prove it in court and that will be expensive so if he does it will be for a big quantity of money.
This means that from the practical point of view you can exclude him from the company by just avoiding the laywers, he will not be able to understand how much are you earning and how much should he get as dividends, maybe will be for him even hard to demonstrate it, while trying to prove his right for getting the dividend paid will be really expensive, he will have to win in court with a lawyer and he may just give up.
In the end Eduardo sued Mark after the big success.
UPDATE ———————————————————————-
@TomTom I do agree with you. The share needs to be protected and only a capital increase may change the value of the company, so that the voting rights in the company could change also. Shares can have special voting rights so they may loose the majority stake or they may see their minority stake decreased, but still have total control of the company. Still I think shares will be diluted if the is a capital increase, but as you say they will keep or have a better fair value. The practice is, if your net profits are less then 10.000-30.000 Euros per year, it may not be worth having lawyers solve this issue.
To solve this problem without using lawyers, the best way is just having the majority shareholders voting for giving a salary to themself (the 3 Directors) for the duties they are doing. Nothing big, just a normal salary. So if they are in 10.000-40.000 Euros Net Profit per year, they may be able to considerably decrease the Net Profit and make it nonsense for the fourth shareholder to not contribute with work to the company.
I have to say that I have been in similar situations in my life and psychological factors can be the best way to solve this issue. Often Employees will not be able to face failure and rejection from others, so probably giving negative looks in the work environment, having everybody against him etc… may push him away from the company
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