How to pre-empt disputes when all is well to avoid conflict when founders fall out 

Everything is going hunky-dory. The company is growing, key talents are being hired, new contracts are being signed and investors are investing money into your company.

You and your co-founder(s) are excited and you feel that your meeting with your co-founders (perhaps matched at an accelerator or by others) is the best thing that could have happened in your entrepreneurial journey, and all of you are working together towards building the next big unicorn.

Yet somehow, things are not clicking.

There are some signs that the initial founder chemistry (which was so good at one time that one founder would be able to complete the other founder’s sentence) is now looking somewhat reduced. Any one or more of the following scenarios could be happening:

• Co-founder is having medical issues either with oneself or within one’s family;

• Co-founder is having family issues either with the spouse or within the family;

• Co-founder is losing interest and looking elsewhere for opportunities;

• Co-founder is unable to manage the team or make firm decisions;

• Founders had an argument due to misalignment of vision or work contributions or both;

• Co-founder was found stealing or committing a crime;

• Co-founder is not taking his responsibility seriously or is more keen on watching the crypto market or watching movies or playing games;

• Co-founders are trying to coerce another co-founder to make changes to the company that is not acceptable to the co-founder (i.e. retrenchments etc);

• Co-founders do not agree on hiring of an employee or on bringing on-board a new investor;

• An alpha or prima donna personality has emerged among founders and causing friction among the founders;

• Co-founder’s skill set is growing slower than the growth trajectory of the company;

• Co-founder does not have relevant experience managing a fast-growing business;

• Co-founder is not committed to the business due to various side distractions; or

• Any other reason under the sun.

Any of these scenarios would cause anguish and stress and result in conflict or falling out among founders.

Founders then face an unpleasant breakup or one wanting to reluctantly step away from a startup for which one has shed blood, sweat and tears for some years.

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Such events have arisen even more frequently in the backdrop of the growth and maturing of the startup ecosystem in Asia, with more companies moving into later stages of fundraising.

Conflicts often revolve around existing or pending unequal contributions of founders, and often one or more co-founders choose to leave the company for the benefit of everyone else (or be “forced” to exit in some manner).

How might founders pre-empt conflict within the leadership and find ways to manage such issues?

Build trust through common grounds

Co-founders of successful companies often have some ground in common – be it knowing each other’s families or having common beliefs (even religious beliefs), or having spent time working together under different circumstances and having an understanding of each other’s strengths and weaknesses. Such co-founders tend to have longer lasting founder relationships.

It is akin to marriage – one has to spend time working on the relationship just like how one is working hard to build the company.

Having something in common (other than fighting in the trenches) would often help build stronger bridges, which can help in navigating conflicts.

Some potential partners even attempt to spend some time working in collaboration on a particular idea or short-term project to determine their chemistry, “fit” and alignment before committing to a longer-term business relationship.

Corporate governance: Accountability and responsibilities

Co-founders need to understand that they are building a company and not just a startup, and monies of investors or personal monies and livelihoods of employees are at stake. One should look at establishing, from the early days, routines, reviews, systems and processes and most importantly a culture that reflects accountability at every turn.

Related to the above is that particular domains (i.e. sales, marketing, hiring, product, operations, fundraising etc) should be assigned to each co-founder to take charge and make decisions. Founders may discuss and argue, but ultimately one should respect the decision made by the co-founder responsible or accountable for that domain.

In other words, each co-founder should “own” their respective domain and be responsible for the decisions relating to the domain. Everyone agrees to hear each other out when an issue comes up, but once the domain-owner decides, founders should then be aligned to move on based on the decision made.

This approach would be preferable to one where any one or more co-founders micro-manages or is involved in various domains even if such domain is not his or her area of expertise or competence, giving rise to potential for friction and misalignment.

Building trust in one another and working hard at trust-building and taking responsibility – just like one would do in any personal relationship – is critical to founders’ relationships. However if that trust is adversely affected for any reason or accountability is lacking, then it may be better to resolve it through a conflict management process or find ways to exit in a manner fair to the company and those who stay behind.

Founder’s agreement: navigating relationships through the written form

A founders’ agreement is often recommended, although it is observed not to be a common practice in this part of the world. One could speculate that this situation arises because founders here prefer to work on the exciting start and growth of the company than to discuss (uneasily) at an early stage about relationship breakdowns or how to resolve disputes among themselves in a formal manner. They prefer to leave such an event to be handled later if it arises or to some informal understanding among themselves, only to encounter confusion and angst when a conflict arises.

The founders’ agreement helps to align expectations and responsibilities, provide clarity of thought around each person’s contributions, domain responsibility, intellectual property assignment, and mechanisms around how any conflict is to be managed. It can also contain clauses regarding any proposed exits – including language as to what events make one a “good leaver” versus a ”bad leaver”, and who would make a final determination around such circumstances.

Also key would be clauses regarding equity split among founders (one should also consider avoiding 50:50 shareholdings as that can lead to deadlocks), and the terms around vesting and clawback mechanisms relating to vested versus unvested shares if a co-founder is to exit from the company.

If the above is not addressed, then the mechanisms should be incorporated in shareholders’ agreement or the company’s constitution, particularly around founder vesting and clawback mechanisms.

In early stage transactions, shares owned by a founder may already be issued on record but could be subject to vesting restrictions, so that until the shares are “vested”, the founder does not fully “own” them (even if it does not reflect as such on statutory records maintained with the regulator).

This is important because equity vesting disincentivises a co-founder from leaving after only a few months and yet retaining significant equity in the company that can otherwise be utilised towards incentivising other employees or key hires.

Founders and investors will not want someone to hold significant equity and no longer be contributing to the company’s growth and success.

To pre-empt such events, one can agree on clauses that determine the period of vesting, circumstances when equity is deemed vested versus unvested, how such equity would be clawed back by the company if a co-founder exits and method of valuing such equity.

Each co-founder should feel comfortable about the requirements and terms relating to their allocated responsibilities, equity vesting and clawback. If any such term causes angst due to lack of clarity or does not incentivise performance, then such clauses are probably not drafted appropriately and should be rectified sooner rather than later.

When conflict arises, bring in an “adviser” to mediate

This discussion is not about getting ready to sue or start a legal claim – that is best discussed with lawyers. But what happens when a potential conflict or point of contention starts to arise?

Quite often, founders or companies have formal or informal advisers who would be professionals or someone experienced in a field that is helpful to plugging the gaps in a founder’s skill set or knowledge. In the event of any conflict, it is always helpful to involve such an adviser that the founders would trust and respect, to be the neutral objective third party who can hear both sides and provide suggestions to approach the issue and move ahead.

In the absence of such adviser(s), one can consider approaching the independent director/ investor-director on the company’s board or seeking assistance from either experienced entrepreneurs, lawyers or professional service providers to mediate the issue. One can approach such third party either individually (to help you respond to the ongoing conflict) or as a group (so as to jointly share any information on the matter). Having a respected third party whom the founders are willing to listen to can often help salvage the situation, manage the personalities, share experiences and provide an approach towards resolving the issue in contention.

What if a dispute does arise, founders have a falling out or it is not clear what to do? In such an instance, it would be prudent to speak to a lawyer or in-house counsel for assistance. .

One should be prudent when it comes to relationships among founders (especially during good times) and raise any concerns or issues and iron out the details upfront. This saves time in determining issues subsequently, especially when emotions get involved. It would also be challenging at later stages as the company grows and the equity increases in value.

Founders should consider being aligned on values, principles and responsibilities through conversations early on, and be involved in constant communication to maintain and grow the relationships. In addition, having a well-thought-out agreement among founders that adds clarity around managing conflict and provides a mechanism on handling exits gracefully would support the growth of one’s investment and maintain reputation and momentum of the emerging entity.

The writer is senior partner and co-head of venture tech and emerging growth companies practice group at Dentons Rodyk & Davidson LLP