Starting your own business is starting a journey. Many business founders set off on this journey with a co-founder or partner, someone that will help navigate the growth and development of their startup business. Often times, there may be three or four co-founders, all owning and contributing to the business in a particular way. However, the journey itself is not always smooth sailing, as co-founders may inevitably face a number of ups and downs. One of those challenges is the co-founder breakup. There are many reasons why a key individual you started your journey with may decide to leave the company or firm. Whether you have conflicts in your respective visions for the company, inconsolable differences in working style, or there are amicable reasons for ending the relationship, there are many legal implications of a co-founder calling it quits on the business you built together. This article will outline the important considerations business founders should take into account before, during, and after a co-founder breakup to best protect their interests, the interests of the business, and the interests of the departing co-founder.
Co-Founders versus Partners
First, let’s turn the page back to the very start of your business and the foundation of your relationship—your business’s structure. How you navigate your co-founder breakup will depend largely on whether your business is a corporation or a partnership. The term co-founder is not a legal term. On its own, the term does not hold any special rights or obligations. The role of co-founder is substantiated by rights and obligations assigned to it through founder agreements, intellectual property ownership, employment contracts, and equity ownership in the business. Registered partnerships, however, are legal relationships, in which the terms are governed either by statute and regulations, or a partnership agreement. Absent of a partnership agreement, the law dictated the rights and obligations of each partner upon dissolution.
Co-Founder and Partnership Agreements
Once you have determined the underlying structure of your co-founder relationship, the next step is to identify whether you have a founders’ agreement or a partnership agreement in place. A founders agreement is a contract you enter into with your co-founders at the start of your business, which may outline all the roles, rights, and responsibilities of each founder. This information may also be incorporated into the bylaws of the company. Such an agreement, if in place and appropriately drafted, will include provisions regarding matters such as the assignment of intellectual property, vesting schedule, ownership, and the removal or departure of founders. A partnership agreement will likewise have similar provisions in governing the partnership relationship. These agreements will serve as a guide when navigating the breakup of your cofounder relationship. However, if there is no agreement in place regarding a corporation, you and your co-founder will have to negotiate on key terms that will be outlined in detail below. In the case of a partnership, the departure may be governed by the law, depending on the existence of a partnership agreement, and will be addressed in the final section.
Ownership of Equity
The nature of the co-founder relationship could allow for the departing half to own a substantial amount of the equity in the company. As a remaining founder, you may choose to repurchase or redeem the shares your departing co-founder owns. This is especially important in situations where the co-founder may own over 50% or 66.67% of the shares, which are the voting thresholds for legally controlling the board and making other changes to the corporate structure respectfully. When repurchasing or redeeming shares, it is important to refer to the two key documents you have in place: articles of incorporation and shareholders agreements.
The articles of incorporation are required by the Canadian Business Corporations Act to include information regarding the classes of shares and any maximum number that the corporation is authorized to issue, as well as information for situations where there is more than one class of shares or if a class of shares may be issued in series. Shareholders’ agreements on the other hand, are agreements outlining the rights of the shareholder or stockholder. They can include some key provisions including redemption clauses which give the company priority in buying shares of the company from shareholders, repurchase clauses which outline how much and under what circumstances shares may be repurchased by the company, or shotgun clauses which may force a partner to sell their stake under certain circumstances. These agreements outline how you may navigate the buyback of shares from your co-founder in situations where it may feel prudent to do so.
Intellectual Property
Intellectual property (IP) is protected in law through copyright, patents, and trademarks. It is important to take into consideration, upon the breakup of your co-founder relationship, who is registered as the owner of any intellectual property that is vital to the operation or differentiation of your business to ensure that it is held in the company’s name. Issues of intellectual property may also arise in the course of employment of a co-founder, if they are employed by the company in any position, including for example as high-level officers. There are three ways that businesses can protect their intellectual property in the course of employment, through confidentiality agreements, non-disclosure agreements, and restrictive covenants in the employment contract. It is important to note that the law does not favour the corporation regarding intellectual property, so in the case that there is no explicit clause assigning the IP rights to the corporation, the courts may implement a test to determine ownership. The test is comprised of questions that assess whether the employee was hired for the express purpose of inventing, whether the employee previously made inventions, whether the employer has incentive plans encouraging product development, whether the conduct of the employee after the creation of the invention suggested ownership was held by the employer, etc.
Employment
Finally, as a small or medium-sized business, it is likely that your co-founder occupies a high-level employment position in the company such as the Chief Operating Officer or the Chief Executive Officer. In these cases, another important agreement to take into consideration is the employment contract. Employment contracts govern the rights of the employee while working at the corporation and likewise include provisions regarding their termination (whether initiated by the company or by the employee themselves). These rights may include, for example, reasonable notice, benefits and compensation, etc. Your employment contract may also cover important considerations that have already been discussed, including matters related to intellectual property, equity, and vesting. If you do not have a co-founder agreement in place, it may such that your employment contract with your co-founder will address some key considerations as well.
Departing Partners
Navigating the breakup of a cofounder relationship is different when your business is a registered partnership. Since partnerships are the product of those who create them, and not a separate legal entity such as in the case of a corporation, the departure of a partner means the dissolution of the general partnership. The way that your partnership will be concluded and the rights of each respective party, will be highly dependent on the reasons for dissolution, including for fraud or misrepresentation, death or insolvency of a partner, incapacity, etc. Partners are typically entitled to share equally in the profits and liabilities of the partnership. In a limited partnership in Ontario, the retirement, death, or incapacity of a general partner will likewise dissolve the partnership; unless the business is continued by the remaining general partners, pursuant to a right to do so outlined in the partnership agreement, and with the consent of all the remaining partners. Limited partners also have the right to dissolve the limited partnership and have its affairs wound up in situations where (1) they are entitled to the return of their contributions, but those contributions are not returned when demanded or (2) where other liabilities of the limited partnership have not been paid or limited partnership assets are insufficient to pay for the entitled return of contributions.
Takeaway
Navigating a co-founder breakup can be complicated and is a highly contextual issue. This issue can be compounded when the rights and obligations of the co-founders are not immediately outlined in the outset of the business. Regardless of whether you have concrete employment, partnership, or founder agreements in place, it is important to fully understand how the co-founder split might impact your business and interests as a remaining co-founder to ensure the continued success of your company long after the breakup.
The content of this article is written for general information purposes only and does not constitute specific legal advice. This article should not be used as a substitute for competent legal advice from a licensed lawyer. Please contact us if you’d like to speak to an Emerge Law lawyer.