You’ve decided to start a new technology company with several colleagues from your past and present employers, and a college friend with a background in finance. Everyone is excited about the new venture. That excitement, however, sometime clouds what would otherwise be the group’s methodical planning process and thoughtful execution of the business plan to start and launch your new enterprise. It’s critically important that the founders agree early on, and properly document, each of their roles and responsibilities in the new technology startup. Without it chaos and conflict will ensue and failure is almost certain.
Document Each Shareholder’s Ownership Interest Right Away
It’s safe to assume that each founder will be an equal shareholder in the new company when you launch the venture. At the very first board meeting, review the articles of incorporation to make sure you understand the capitalization of your company, including the number of common and preferred shares the articles authorize your company to issue. Ask your accountant to create a spread sheet that contains the company’s capitalization table. At this first meeting it will probably contain only a few line items, including how many shares of common stock each founder owns and how many shares of common stock the board has decided to set aside for the company’s equity incentive plan. As time goes by, and the company grows, the capitalization table will add lines that show the number of shares (or options) held by each director, each officer, and new employee as they are brought on board. Your stake may also increase because part of you employment compensation may include additional grants of restricted stock or stock options, as decided upon and at the sole discretion of the board. If at all possible, avoid at all costs identifying each individual founder’s – or anyone else’s – percentage ownership of the company. One of the fastest ways to create a conflict among founders is to circulate a capitalization table that specifies each person’s percentage ownership interests in the company. It’s an unnecessary number that people fixate upon that only creates conflict. Avoid it.
Establish the Board of Directors and the Schedule and Procedures it Follows
At the outset, each founder will probably have a seat on the board of directors, and be counted upon to attend meetings and participate in the decision making process that guides the company’s future and fortunes. Make sure your board is comprised of an odd number of directors (i.e., 3, 5, 7 and so on). One of the easiest ways to bring a corporation to its knees is for a deadlock to emerge among the board members when the company has an even number of directors. It’s corporate suicide; don’t do it.
Make sure you conduct each board meeting in person – or at least by videoconference – so you can see and hear one another when you discuss each item on the board’s agenda for that meeting. Make sure you prepare an agenda for each board meeting that addresses the important issues confronting each aspect of your business at that time. This will almost certainly include a discussion of how much money you have in the bank, recruiting and hiring employees, developing products, developing a prototype, rolling out of a beta version of your technology for customers, managing the burn rate of your cash, and soliciting investors to raise additional funding.
At your very first board meeting you should set out in writing the roles and responsibilities that each founder will assume in the company, including those areas of the day-to-day operations of the business for which each of founder is responsible. Play to your genuine strengths. It will benefit the company, accomplish the milestones in your business plan, and help you attract investors. Write down the roles and responsibilities of each founder as clearly and detailed as possible. Avoid overlapping responsibilities that may at a future board meeting – hopefully not attended by prospective investors – lead founders to point fingers at one another when vaguely assigned tasks fail to get done. “I thought you were doing that.” Spell out each founder’s roles and responsibilities in a set of board resolutions approved by a majority of directors, and include it in the corporation’s minute book. Make sure that each founder knows that within the scope of her day-to-day authority the buck stops with her, and if she wants a friend, get a dog. Founding a technology company is not for the faint of heart.
Create a Management Mechanism to Resolve Disputes
Early in the formation of the company, the board of directors should create a mechanism for resolving disputes that arise among founders. Each founder will likely feel a deeply personal connection to the company and its mission. That emotional connection does not always make for the best business decisions. You and your co-founders may find yourselves disagreeing on any number of day-to-day issues or, more likely, large fundamental issues, like raising more money, selling the company, or even dissolving and winding down the company.
You may be able to resolve disputes that emerge among founders at the board level. Simply bring the problem to the board, identify and discuss the pros, cons and costs of each potential solution, and then vote on it. For most decisions, the majority will rule. For big decisions you may wish to include a provision in your bylaws that requires a super majority to resolve disputes that arise around existential problems that confront the company from time to time. Resolving founders’ disputes at the board level may create hard feelings that hamper one or more founders from remaining committed to the enterprise and performing well in the future. So another way to resolve disputes among founders is to retain, as an independent director or advisor, a wise person who has run or worked in technology companies for many decades, and can bring that experience to bear in your company to help you resolve particularly difficult issues. Resolving disputes in this fashion can ameliorate the hard feelings that may arise among founders – particularly those who lose the debate – and has the advantage of being based on objective commercial criteria that at the end of the day is in the best interests of the company, regardless of who might be offended.
Finally, from the outset, the board should create a process to make existential decisions for the company. Doing so will help the directors fulfill their fiduciary duties to the company and its shareholders. It will also help the directors develop and implement a methodical, disciplined and analytical approach when an existential decision that confronts the company arises. Whether to raise another round of financing with new investors, and thereby dilute the existing shareholders and investors, is a significant decision. Whether to acquire a competitor or place the company on the block for sale is a significant decision that warrants a thoughtful process before the decision is taken. Whether to dissolve and wind down your company is entitled to the same thoughtful process because it will bring your venture to an end. The sooner the board creates a process for identifying, analyzing and deciding these momentous decisions the better because frequently these types of events occur unanticipated and must be acted upon quickly.
Establish Clear Roles Among the Founders for Day-to-Day Management
At the outset, with or without a title, each founder will likely be asked to assume substantial responsibility for some aspect of the company’s business. This could include product development or sales and marketing or financial management or fund raising from investors. The lines of authority and the assigned roles and responsibilities may not always be clear. The founders responsible for managing day-to-day activities, like hiring employees and developing products, may not always see eye-to-eye with the founder responsible for carefully managing the company’s limited resources (read, “cash”), who may in turn not agree with the efforts of the founder assigned to pitch the company’s vision and products to prospective investors. The longer that you allow vague areas of responsibility and haphazard decision making to prevail in the company the greater the chances the founders will not accomplish what each has been asked to do, and conflict will almost certainly emerge. This is last thing your team needs when you’re working 24/7 to start and launch a new business.
To avoid these all too common pitfalls, formalize the working relationships among the company’s founders as early as possible in the company’s history. Avoid acting through casual business relationships, even among friends and family. You hired a lawyer at great cost to prepare your articles of incorporation, bylaws and organizational resolutions. Read them, know them, and follow them. They can, if you like, include detailed – or not so detailed – statements of what each founder’s roles and responsibilities are. Conduct formal board meetings on a periodic basis, whether monthly, bimonthly or quarterly. At the outset, anything less will allow problems to fester or go unnoticed for too long, which will make the board’s task that much more difficult when it finally identifies, confronts and tries to solve those problems. For instance, the risk of running out of money should be identified and addressed immediately because if you do run out of money you may be forced to file for bankruptcy, and your creditors may be sufficiently upset to pursue you personally for the money they believe they are owed by your company.
Create a Written Process the Board Follows When a Founder Departs
There will inevitably come a time when a founder departs the company. That is a difficult time for both the departing and the remaining founders. It is important for business and personal reasons to anticipate, plan for such events, and create a process the board will follow to determine the terms under which the founder may depart and how much of her equity stake she can retain. The decision is typically guided by two documents; sometimes one, sometimes both. The bylaws should state in some detail, but not great detail, what happens to a departing founder’s stock when she leaves the company. More often, however, a founder’s stock purchase agreement – or restricted stock purchase agreement – will set forth in detail the method by which the board decides how much, if any, equity the departing founder will retain in the company. Sometimes the departing founder is allowed to keep all of her stock. Sometimes the company retains a right to repurchase a certain amount of the founder’s stock at fair market value. Sometimes a departing founder will forfeit all or portion of her stock if she is found to have engaged in dishonest, unlawful or immoral behavior harmful to the company. Sometimes the departing founder retains voting rights in her stock and sometimes she doesn’t. The contract – and the bylaws – define the legal process the board must follow when a founder leaves. So when you negotiate each founder’s stock purchase agreement be cognizant of the fact that when one of your co-founders leaves the company the remaining founders – and the company – will have to live with the consequences of the original contract, good, bad or otherwise.
About the Finkel Law Group
Finkel Law Group, with offices in San Francisco and Oakland, has more than 25 years of experience providing legal counsel to the founders, directors and officers of technology startups operating in a variety of industries to help them negotiate and properly document all forms of business transactions, including articles of incorporation, bylaws and founders’ stock purchase agreements. When you need intelligent, insightful, conscientious and cost-effective legal counsel to assist you with the formation, business transaction or investment you’re contemplating for your technology company, please contact us at (415) 252-9600, (510) 344-6601, or info@finkellawgroup.com to speak with one of our attorneys about your matter.