Top Issues Between Co-Founders and How to Protect Yourself

by General Standards

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Starting a business can be one of the most rewarding, exciting, and stressful things you ever do. While forming a company with others can often makes a huge amount sense, as each person can bring unique skills and experience to the business, it is certainly not uncommon for issues or differences to arise down the track that founders simply do not foresee at the beginning of their relationship. Fortunately, both New York (NY) and Delaware (DE) law allow businesses to structure their organizational documents so that these issues can be adequately prepared for before they come up. Two of the big ones to keep in mind are:

Transfer of Ownership Interests

Whether you have a corporation, LLC or partnership, there may come a time when one of the founders decides to part ways with the company. When that happens, typically the existing owners will want tight control over who can purchase the ownership interests of the departing individual, and how this process is managed. Your corporate bylaws, LLC operating agreement, or partnership agreement can (and absolutely should) contain provisions that dictate how ownerships interests are transferred.

First, most LLCs (though corporations can also be structured this way) are set up so that all of the remaining Members would have to agree to any transfer of ownership interests. This can be modified so that only majority, or supermajority, consent is needed, but either way this puts some power in the hands of the remaining owners.

Second, you can include a right of first refusal in your bylaws, operating agreement or partnership agreement. A typical right of first refusal provision would require a departing owner to first offer his or her ownership interests to the existing shareholders, Members or partners. If none of the existing owners want to purchase the interests, then the departing owner may find a buyer on the open market. Once a buyer is found, that buyer’s offer would be communicated to the remaining owners who, once again, would be given a chance to purchase the interests at the same price. If the owners again reject the offer, then the departing owner can sell his interests to the third party.

Third, some companies have provisions regarding what happens to an owner’s interests in the event he or she gets divorced. Since most states would treat company ownership as a personal property interest, the founders may want to include language in the bylaws, operating agreement or partnership agreement that specifies that a divorcing member must sell, or that interests passing to the ex-spouse will be purely economic interests (with no voting or management rights), or any other provision that the founders agree upon.

Non-Performance or Under-Performance

In addition to including sections in your bylaws, operating agreement or partnership agreement that specify the procedure to be followed in the event a founder voluntarily wants to leave the company, one situation that is frequently left unaddressed in company documents is what to do in the event a founder fails to perform his or her duties. Without clearly specifying what each founder’s roles and responsibilities are, either in the formation documents or in a separate agreement, it is nearly impossible to involuntarily remove a founder from his or her position. This type of provision would typically specify what relevant the performance measure are involved, and include procedures for voting on performance by the remaining owners and for returning the removed owner’s capital contribution and any profits earned to that point. If you take the time to not only state what each person’s responsibilities are to the company, but also include provisions that permit the founders to reasonably remove a non-performing or under-performing owner, then you will ensure a smoother transition in the event you encounter this type of circumstance.

If you want to learn more about your rights as a co-founder, book an appointment with a General Standards attorney here.