Previously, I highlighted the legal aspects of structuring founder agreements. These are indeed very important but it is even more important to underscore that any agreement can be modified if the parties involved agree to do so. Therefore, a non-confrontational, positive approach is always the best way for a founding team to approach removing a co-founder. It is better to err on the side of being reasonable and generous to make things simple, quick and not get into legal disputes.
My key message to founding teams is the following: think very carefully about how you want to distribute decision-making power amongst the team, especially regarding key issues such as CEO and board roles. Just as I prefer balanced, independent boards where no one person or entity exerts too much control, I prefer companies where no one founder can force or block key votes against the wishes of the rest of the founding team and investors.
In many cases of misbehaving founders weak boards and weak investors are to blame also. A couple of months ago I had lunch with an exec at a large startup in Boston. We talked about his absentee CEO who spent most his time in another country. Growth in the company had gotten sluggish because of lack of investment in R&D and the go-to-market organization. The CEO, who is well-known in the community as a control freak, doesn’t want to increase the burn because that will require a financing. A financing will bring his ownership under the threshold that allows him to block his replacement by the board. He’s made money in the past so now he’d rather be king. What surprised me about the story is that experienced VCs from two well-known firms twice didn’t confront this situation. For two rounds they were enamored-enough to invest in the company despite the unreasonable degree of control the CEO had. Now they have so much capital into the company, they can’t risk abandoning it.
If you want to build a better-balanced founding team where no one founder is irreplaceable, you may want to consider the following list of ten guidelines:
- Clear agreements. Have clear verbal or, better, written agreements pre-incorporation. While agreements can be adjusted later, doing so typically requires consent and that potentially gives too much power to individuals.
- Founder drag-along. I haven’t seen this used in practice prior to financings but it seems that a reasonable approach to (1) would be to give the founding team an ability to drag along a reluctant co-founder.
- Vesting. With the exceptions of the investor and certain types of advisor roles as discussed in my previous post, everyone else on the founding team should vest. (Here are my thoughts on the best vesting schedule for founders.)
- Consider a vesting cliff. Standard founder agreements don’t have vesting cliffs for founders. This assumes that co-founders know each other well and have experience working with each other. That’s not always the case.
- Align vesting with value-add. Typical founder vesting schedules are time-based. That works well for full-time employees but is a poor fit in the case of part-timers with flexible involvement or situations where there is a non-linear value contribution. I face this in my FastIgnite work frequently as I deliver much of my value up-front.
- Understand voting thresholds. As you divvy up ownership amongst co-founders, think about what that will look like under a range of cap table scenarios given a financing. Be careful of any founder getting too much power.
- Be careful with big severance packages. I saw a bootstrapped company looking for funding where the lead founder had written his agreement such that if he was terminated he could call “the loans” he’d given to the company during the bootstrapping period. With interest, it was over $1M. Also, don’t go for big vesting acceleration on termination without cause.
- Don’t give board seats by name. Same message as above—don’t design inflexibility in unless you have a darn good reason. Question the balls of investors who want in the deal so much they are willing to go along with highly unusual board or voting structures.
- Alternate founders on the board. Even if one founder, through her shareholding, can ensure a board seat all the time, you may want to discuss options that involve term limits or some type of representation alternation with your co-founders. In one of my investments, two co-founders alternated every few months. It worked well.
- Strong, independent boards. There would be fewer scandals on Wall Street if more public companies had strong, truly independent boards. In startups, it is relatively common for investors or a founder or the CEO to bring a “friend” on the board. Nothing wrong with that if the friend cares about the company first and foremost.