A pressure cooker environment: How to minimise the pain of a co-founder breakup

A team of two co-founders is widely considered the optimum number for a successful startup.

This is supported by empirical evidence and high-profile examples such as Google, Apple and Netscape.

Indeed, married co-founders are the ultimate startup partnership and have reportedly been chalking up large funding cheques and exciting exit opportunities in recent times.

But not all co-founders live happily ever after, and co-founder divorces are often as emotionally charged as a real marriage breakup. They are also very common, with estimates of co-founder breakups ranging from 35% to 45% of all startups.

As an investor, I have certainly been involved in a significant amount of ‘marriage counselling’ between founders.

A startup is a pressure cooker environment.

Co-founder relationships are beset with challenges ranging from personality differences to conflicting views on startup strategy. This is often exacerbated by a short courtship where founders may not have previously worked closely together. Long hours and limited cash can compound stress.

Not all co-founder exits are malevolent.

A co-founder breakup may be due to an amicable parting of ways or a founder needing to exit for personal reasons such as illness. It is also true that even the most amicable of splits can turn sour when money is involved.

There is one thing that all founders should have in place to ensure that any breakup is without too much pain and suffering, and this a vesting agreement. It is the startup equivalent to a prenuptial agreement.

It is never too early to put a vesting agreement in place. It may seem awkward, but it is absolutely necessary to protect co-founders from each other.

The industry standard is a schedule of four years with a 12-month cliff, and monthly or quarterly vesting thereafter. The 12-month cliff means founders need to contribute to the company for at least one year for their first increment of equity to vest.

If a founder leaves the startup after the first 12 months but before the end of the four-year period before the shares are fully vested, the startup has the right to buy back the unvested shares.

Leaver provisions should cover all possible exit scenarios: the good, the bad and the ugly.

A vesting agreement almost always has good and bad leaver provisions. The circumstances in which a founder leaves will determine how much a founder is able to keep their vested shares.

Good leavers are generally entitled to keep all of their vested shares with unvested shares being bought back by the startup for nominal consideration.

A bad leaver event usually involves an element of fault on behalf of the departing co-founder. This might involve leaving to set up a business in competition, or actions such as committing fraud or a criminal offence. A bad leaver may be penalised by forfeiting some previously vested shares or in some cases, where there has been serious culpability of a co-founder, all previously vested shares may be forfeited.

Vesting can be accelerated in certain circumstances and the implications should be clearly outlined in the agreement.

Vesting can be accelerated if the company is sold before the original vesting schedule is achieved. This means co-founders will realise the full market value of their shares when the sale occurs.

Acceleration of vesting might also follow a sale if the buyer materially changes a founder’s responsibilities or moves the place of work by a significant distance. These provisions all accelerate vesting of unvested co-founder shares.

When a co-founder leaves unvested shares on the table, a number of possible scenarios can unfold.

By design, founders are incentivised to stay until their shares are fully vested, but if they do leave, their unvested shares become available immediately to existing team members or to help attract new talent. This negates the need to issue new shares that dilute existing shareholders as the departing co-founder’s shares have been returned to the ESOP pool.

Regaining control of the shares also prevents the unappealing situation of founders working to grow the equity value of a former co-founder, who may end up as a competitor.

When a breakup gets messy, it chews up the two resources that are most scarce, precious and finite for any startup: time and money.

Using a vesting agreement to prepare for all possible scenarios between founders is the secret to the long-term success of startups in general.

This is true regardless of whether the outcome of the founders’ relationship is a life-long partnership or a parting of ways.

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