As a startup attorney with 15 years of experience, I see startup and founder dispute scenarios on a daily basis.
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Harvard Business School professor Noam Wasserman famously determined that 65% of startups fail as a result of founder conflict. Startups have neither the time nor resources to litigate the dissolution of partnerships, or to divvy up ownership as circumstances change. Preventing and managing founder disputes is crucial. Let’s take a look at a specific incident of equity-related conflict between co-founders.
“My co-founder is threatening to quit unless I give them more equity. What should I do?”
Assuming that you are the majority owner of your company and can make equity decisions unilaterally, there are three things you should consider:
Is your co-founder being reasonable?
When you initially allocated equity to your co-founder, you may have been too conservative. There is no out-of-the-box equity allocation. Relatively equal splits can make sense, but they are not the norm. It is sensible to adjust initial equity between founders based on factors such as prior successful startup experience, one founder having worked on the idea first, or the critical value of one founder based on technical or other skills.
If you are that “dominant” founder, there may have been valid reasons to negotiate a significantly larger share of the equity. For example, maybe you were trying to build a dilution cushion. In that case, after several months or more have gone by and your co-founder is balking at their equity stake, you might realize that you didn’t need as much of a cushion as you thought. Perhaps you thought you would need more hires than you actually end up needing or those hires are asking for less equity than you thought.
Did you and your co-founder agree to re-evaluate equity distribution in the future? This could happen if you were originally testing the waters with your co-founder before giving more equity. If that’s the case, then it is likely entirely reasonable for your co-founder to demand more equity. At that point, you should negotiate in good faith. If, early on, you correctly communicated an informal agreement to re-evaluate equity in the future, you would not be legally obligated to give your co-founder anything more. But you should be prepared for them to leave if their needs aren’t met.
The other situation in which it is reasonable for your co-founder to demand more equity is if responsibilities within the company have changed significantly. In other words, if the initial assumptions that led to your agreement on an equity split change, it is proper to renegotiate. For example, maybe your co-founder was originally only working for the company part-time, or started taking on new responsibilities that were previously handled by personnel that left the company. It’s always proper to renegotiate under such circumstances.
Is it time to cut ties with your co-founder?
On the other hand, it’s possible that your co-founder isn’t being reasonable. If that is the case, it may mean that their position within the company and as a co-founder needs to change. You may see your co-founder as an indispensable part of your company, but if you give into such threats, your co-founder may be able to extort more value out of the company.
If your company is still at an early stage, this may be the most painless time to part ways, regardless of how valuable your co-founder may be. Chances are that if they seem indispensable at the beginning, it will be more difficult to remove them later. Do this quickly and cleanly, as soon as the required legal infrastructures are in place. Be careful in mollifying them temporarily while coming up with alternative plans. This could lead to a messy co-founder breakup.
What do your investors and advisors think of the situation?
Any delicate situation regarding equity is best handled with an advisor, and when appropriate, with investors as well. They may be able to mediate and help your co-founder understand what is and what isn’t reasonable. Additionally, they may be able to help you see a compromise on your end that wasn’t previously evident to you.
The key thing to remember in a scenario like this is that a problematic co-founder can be extremely dangerous to the longevity of your company, so these issues need to be addressed as early and as delicately as possible. At the same time, you must be able to see your own position and decisions clearly. The give and take of leadership is extremely important.