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Founder dynamics can propel a company into the S&P 500—or send it into a steep decline. Unfortunately, not every startup relationship is a perfect match. When a co-founder leaves earlier than expected, it’s critical to get ahead of the legal issues that follow.
A co-founder’s departure will inevitably affect your team’s operations, workflow, and focus. This article outlines key considerations to keep in mind if your co-founder heads for the door—whether the exit is planned or comes as a surprise.
Reviewing Relevant Agreements & Provisions
A number of foundational agreements—such as restricted share purchase agreements, IP assignments, and severance agreements—may be directly engaged when a co-founder leaves. These documents govern everything from equity rights to post-employment obligations, so review them carefully (ideally with legal counsel). Pay particular attention to:
- Termination vs. Voluntary Departure
Whether a co-founder is terminated or leaves voluntarily can significantly affect what they are entitled to receive upon departure. - Equity Vesting
Does vesting continue after they exit? Are any unvested shares subject to acceleration? Can/should shares be repurchased? - Severance
Is the co-founder entitled to severance? How is it calculated? - Dispute Resolution
If the departure leads to a dispute (which is more common than many expect), what forum and governing law apply? - Non-Competes
Is the co-founder bound by a non-compete? How harmful could it be if they join a competitor?
Sorting Out Securities
If a departing co-founder holds a substantial equity stake, consider whether the company should repurchase some or all of those shares. Former executives who retain 50% or more of voting shares can still control fundamental decisions (sometimes this thresholds is 66.67%). You’ll want to ensure control remains with those actively building the company—either executives and employees or investors. Review your shareholder agreement(s) and articles of incorporation to determine what share redemptions are permitted.
If the departing co-founder chooses to sell their shares to a third party, keep an eye out for any Right of First Refusal (ROFR) provisions. These typically require the co-founder to offer those shares first to the company or certain investors before selling them to an external third-party.
Additionally, confirm whether the co-founder’s equity continues to vest post-departure. The so-called “free rider” problem arises when founders keep accruing equity despite no longer contributing to company growth—allowing them to benefit from the team’s ongoing efforts.
IP Assignment
If a co-founder did not assign their intellectual property to the company at the outset, it is crucial that they do so when they depart. IP should reside with the company—not individual founders. Without proper IP assignments:
- investors may hesitate to provide capital,
- costly and time-consuming ownership disputes may arise in the future, and
- the company’s enterprise value may be diminished.
It’s best practice to secure IP assignments early and consistently—every time a new founder or employee joins the company.
How We Can Help
At Apex Law, we routinely support startups navigating premature founder departures. With our guidance, you can proactively manage risks before they turn into problems and maintain the confidence of your investors and customers.
