How to avoid and resolve disputes in start-ups
Disagreements between the founders of a business are often inevitable. Whilst they may make great business partners at the outset, they may not have fully aligned on the direction and expansion of the business, the founders’ roles, the way the business is managed or funding and exit strategies, with departures from the business having the potential to become particularly contentious. Whilst most disputes can be resolved amicably, some can be totally destructive to the business, which can be mitigated by reaching alignment at an earlier stage.
Agree things from the outset
Disputes can be hugely expensive and time consuming. However, potential problems can be nipped in the bud from the start.
When establishing a start-up business where Founders are on an equal footing at shareholder and board level, consider putting a co-founder agreement in place so that everyone is on the same page about how the business should be run and clearly sets out the rights and obligations of the key stakeholders. It is likely that any investors who later join the business will insist on certain terms (especially regarding leaver provisions and vesting). However, whilst the co-founder agreement is likely to be superseded at some point, there are certain matters that you should decide on before any investors come on board. You should agree:
- The aims for the direction for the business. The founders’ agreed targets, timetable for growth and the vision for the product itself.
- Each founder’s roles and obligations. Who does what in the business.
- Any restrictions on the founders. This might include restrictions on working on other projects.
- Incentivisation to make sure everyone is committed to the business in the long term. This includes salaries, equity incentives and a mechanism for vesting, and in what circumstances shares should be forfeited (for example, if they leave to join a competing business or for health reasons). You should consider whether any equity should be transferred from a departing founder to the remaining founders who continue to drive the growth of the business.
- What happens when people leave. Restrictions can be put in place to prevent leavers from competing with your business or using the business’s IP. Whilst it may be unappealing to think about a founder leaving, you should consider what is best for the business if one founder departs and leaves the other to grow the business.
- Deadlock and dispute resolution provisions. Set out a process for handling any disagreements that do arise to prevent hamstringing the business.
You will also want to consider putting in place non-disclosure agreements with potential investors and other stakeholders if you want to discuss your idea for the business or disclose any proprietary information.
Depending on the structure of your business, founders will almost certainly also have legal obligations to each other and to the business as company directors. These include obligations to act in the best interests of the business, not to make secret profits from the business and to avoid conflicts of interest.
What to do when issues arise
Having this type of agreement in place can help deal with problems when they do arise and regulate behaviour to avoid disputes in the future. You can refer back to your original goals and what you have agreed in order to help negotiate a solution.
As noted above, the agreement should also include deadlock provisions to prevent stalemate in the business if the founders cannot agree on a decision. These types of provisions are designed to break the impasse without going to court by providing a framework for dealing with disagreements. For example, you might wish to identify someone with expertise in the relevant area to advise you and provide guidance, which could help navigate an issue.
If a more serious dispute arises, you could agree to resolve it by mediation, where an experienced third party helps both sides agree on a solution, or perhaps you could refer the dispute to an expert for them to determine the matter. You might also have a buyout clause allowing one founder to exit on terms which ensure a fair price for the exiting shareholder.
Ultimately, the last resort is to go to Court, and this generally only arises where a founder has egregiously breached their obligations under the agreement and/or their duties to the company. Where this happens, you could potentially claim damages or obtain an injunction to prevent them from doing something which would harm the business. However, this is generally very expensive and time consuming. Court cases can drag on for years, are an unwelcome distraction and will likely prevent you from raising further capital. The reality is that having detailed provisions written down from the outset which help you work past any issues are likely to be the best tools to keep things moving forward. The threat of legal action and the respective strength of the parties’ legal positions, however, could be used to help break deadlock and negotiate a positive outcome.
