When Co-Founders Fight, Startups Take a Blow

Having strong negative feelings towards your co-founder does not necessarily mean that your startup is doomed. All you need to do is effectively hide how you feel and be kind and respectful to your partner. Good luck with that.

The problem is, the stressful nature of raising and managing a startup is fertile ground for conflicts between founders, even when they like each other. These conflicts are nearly impossible to hide and may affect a young venture, even destroy it altogether.

Co-founders in disagreement (illustration)

Founders who don’t get along may find it difficult to raise funds. Investors will sniff out the problems while doing their due diligence on the company and its team, and will likely be hesitant to put money into a company whose founders can’t work together.

If the conflict with your co-founder is severe and unsolvable, you should consider disclosing this information to your potential investor. If the relationship deteriorates and negatively influences your performance, e.g., you destroy a commercial deal by fighting over its terms, and it's clear that "the writing was on the wall," you could face serious liability issues. You could face legal action for breaching various representations in the investment agreement or various duties under applicable law, which essentially require that you be honest.

When bad relations between founders hurt a startup's performance, sometimes the only way to move forward is to separate. Strive to buy out or agree on separation terms with one founder so that the rest of the team can succeed. That said, standard founders' agreements rarely provide a clean and neat route to separation.

Most founders' agreements, as detailed and diligently prepared as they are, simply don’t describe a way for founders to separate due to a "disagreement" or "personal disputes." According to most agreements, a founder could be forced out only once he or she has breached "formal" obligations. Without a precise agreement, it will be difficult to decide who remains at the helm, who leaves, and how to compensate the person who walks away.

It is possible to create agreements that allow founders with majority holdings to remove at will other founders with minority holdings. It is more complicated, however, to get smart founders to sign such agreements, taking the risk of being kicked out of the venture they helped start. Even mutual purchase arrangements can be dangerous to the parties in a number of different ways and are usually missing from start-up founders' agreements, and for a good reason.

Consider, for example, a standard BMBY (Buy Me Buy You) mechanism that allows each founder to offer to purchase his or hers co-founder's share for a price determined by the offering founder, or by an agreed arbitrator. If the co-founder who receives the offer refuses to be bought-out, he or she then must purchase the offering co-founder's share, based on the same price per share. This mutual mechanism sounds fair on paper but rarely works out to the mutual satisfaction of both sides.

The conclusion is that, like in a marriage, it is best to do everything possible to protect the project and avoid any irreversible damage that could cause the partnership to fall apart. It is worthwhile to talk about problems as they arise, try to find creative solutions, and compromise. At times founders must put egos aside to protect their investment.

Dueling co-founders (illustration)

And when that doesn't help?

The best thing to do is to find an outside advisor who can assist the rivaling founders agree on a solution that will allow them to continue as long as possible without separating and causing irreversible shocks to the project. The third party could be the company accountant, a lawyer, or a mentor who advises entrepreneurs. This moderator must meet two conditions: (1) they must be considered objective by all sides, and (2) they must have the appropriate experience to find a creative solution.

Sometimes it’s possible to find a solution to the conflict by making substantive changes to the parties’ original agreements. The changes could affect their roles in the project, the time they need to invest, how decisions are taken and so on.

In a situation in which one of the founders simply isn’t contributing to the venture like the rest of the team, a possible solution is to retroactively change the ratio of the founders’ shares. This is an extreme step, but it is probably more profitable for everyone than litigation which, as mentioned, is likely to lead to the break-up of the venture and the loss of all the investment put into the company.

Another common battleground is the way decisions are made within the company. Fixing such issues usually requires taking another look at the way initial agreements define the process and making changes that better fit the way the project is managed now and the challenges it faces. For example, founders of new startups may originally determine that every decision must be made unanimously, but this process no longer benefits a larger business where many more decisions must be made. If the founders' struggle to reach decisions unanimously negatively impacts the way the startup is run, they could replace the requirement and move to a majority decision-making process.

In conclusion, unmanageable founders' disputes may cost a startup dearly in finances, time, and investor support. Only a few early-stage ventures will survive a break-up of the founding team. As a result, the best advice is to do everything possible to overcome emotions and find a creative solution to disputes, either alone or with the help of an external consultant. A number of successful projects have been led by entrepreneurs who weren’t friends but were succeeded in finding solutions that allowed them to work together and reach their goals.

This post was originally published on TheOnlineStartup.

Adv. Zachi Zach is a lawyer and a mentor in the online industry, specializing in online gaming, adtech, ecommerce and other online related fields. Among others, Zachi serves as Of Counsel to the law firm of Pearl Cohen, an international law firm with offices in the US, Israel and the UK.

Zachi is also the author of The Online Startup blog: www.zachizach.com.