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August 21, 2005

The Problem of the Forgotten Founder

Some more thoughts on carefully choosing your co-founders.

Startup teams form in many different ways. Often, the “core” founder does some homework and recruits the founding team. Sometimes, teams are, more or less, recruited by a VC who has a startup idea but needs entrepreneurs to make it a reality. Most often, however, startup teams are formed by people who either currently work together (at the company they’re planning to leave) or who have worked together in the past. In my experience, this process is usually informal and based at least in part on a (sometimes fuzzy) mixture of friendship and perceived competence. As I’ve written in the last two posts, it not infrequently goes wrong because one of the founders doesn’t work out and leaves the company with an equity stake disproportionate to the value he added – to the economic detriment of the remaining founders. 

There’s a flip side to this problem as well. 

I call it the problem of the “forgotten founder,” and here’s how it works. 

As noted above, most often startups are the result of informal “nights and weekends” discussions among friends. Not infrequently, the cast of characters changes over time, with “peripheral” people leaving and joining the core group. Early on, the group rarely has any formal legal structure. That is, the group is not usually formally established as a corporation until the founders “get serious”. Incorporation involves lawyers, and most founders don’t have “that kind of money” – certainly not to spend on lawyers. 

Even after the founding team has coalesced, quit its jobs and decided to “go for it”, a VC financing can take a long time. To entrepreneurs, the VC world moves at a glacial pace, even at its best. During this part of the process, it’s also not unusual for one or more of the founding team to leave. Reasons vary. Quite often, however, the departing team member has a spouse and kids who need to be supported, and their net worth is insufficient to sustain them for long without an income. 

What’s the problem? 

It involves two related legal concepts: (1) what type of legal entity, if any, has been formed during the “nights and weekends” phase and (2) what ownership rights can be claimed by someone who participated in the startup discussion and brainstorming – but who didn’t stay on part of the team. 

Forgotten Founder Situation #1. In the early, informal stages of forming a company, you don’t want to be deemed a “general partnership” – for a bunch of reasons. One important reason is that the rules on (1) whether a general partnership has been formed and (2) who’s a general partner (and therefore possibly entitled to part of the ultimate benefits of a successful venture) are not as clear as the rules involving who’s entitled to a stake in a corporation (or possible other “formal” types of business enterprise you might choose). Believe me, you don’t want someone who participated in some portion of the early brainstorming, but who left and didn’t become part of the continuing team, to later claim that he was a “partner”, helped create your new venture and therefore is entitled to some economic stake in it.

Forgotten Founder Situation #2. The law governing who has rights in different kinds of intellectual property is not always straightforward. Moreover, the law in this area is under development because the facts are usually different in each of the cases that make the law. Who is the “co-inventor” of a patentable idea, or the “author” of a copyrightable work (e.g., software code) is not always intuitive. After several years of blood, sweat and tears to make your startup a success, I guarantee that you will not want to share the fruits of that labor with someone who claims that it was partly their idea, but who didn’t make all the sacrifices you and your co-founders did. 

As a lapsed lawyer, I’m not going to give legal advice – particularly any that can be applied to a particular situation. Indeed, the final bit of advice in this post is to engage a good lawyer early (how to pay for it is also discussed). Entrepreneurs do need to know, however, that sometimes the law can have counter-intuitive results in disputes over who owns what – especially when the “what” is intellectual property. 

Here’s some advice aimed at helping you avoid the “forgotten founder” problem.

First, be careful (not paranoid) about who you include in discussions and/or brainstorming sessions about your new company idea. It’s good to test your idea(s) on constructively critical friends and colleagues, but be careful about having someone whom you don’t intend to have as a co-founder deeply participate in the discussions over an extended period of time. 

Second, keep notes of the discussions, including (in general terms) who said what.

Third, see a lawyer early in the process to make sure the details of your particular situation are kosher and that you’re protected (especially about how to apply my preceding two items of advice to your situation). While lawyers are expensive, most of the good ones will work for promising startups on a deferred or discounted billing arrangement. If the lawyer you’ve been introduced to won’t do this, find another lawyer. The really good ones will. To be clear, even lawyers who focus on startups can’t work forever without getting paid. So prudence and clear communication will also have to be your guides. 

It’s really hard to build a successful startup, even when all the planets align. The startup process throws up plenty of unavoidable problems without any help from you. The problem of the forgotten founder is avoidable. When starting your company, do yourself a favor: avoid it.

August 21, 2005 | Permalink

Comments

Allen,

Can a "founder" expect early help in structuring the right plan when his interest is licensing his proprietary code and not in going the "full course of sprouts" in establishing "his own company"

Thanks,
Burton

Posted by: Burton Floyd | Aug 31, 2005 6:06:32 PM

interesting!

Posted by: Haluk ireskeneli | Sep 6, 2005 10:15:12 AM

All good and reasonable advice ... except that many startups probably never get off the ground because they try to follow this advice.

Imagine: A group of people sitting around, discussing a possible startup. Somebody says, "Let's make it legal to avoid problems down the road." Everybody nods: it's a good idea. So, everybody stops talking about the possible startup and starts talking about how to legally structure it. Somebody asks, "Anybody know a good lawyer?" and, of course, nobody does. So, the group takes a multi-week, possibly a multi-month break, while one guy runs around, reading books and blogs, making appointments with potential lawyers and tries to find a competent, ethical lawyer. Everybody else, not being able to talk or do anything, finds other things to do, like going on dates or having kids. The guy who runs around, possibly returns at a future date and has to round everybody up again. Or, possibly, he loses interest in the whole thing.

Get a good lawyer is certainly good advice. But don't turn it into a roadblock that crushes your possible startup into dust.

Posted by: Daniel Howard | Sep 9, 2005 10:55:46 AM

Would a written agreement on the "conditions for rights" between the members before the "who's in?" phase work?
Such document would potentially prevent any (successful) claims in the future.

Posted by: Saar Drimer | Sep 10, 2005 5:49:11 PM

Allen,

Do "founders" and "co-founders" have any specific legal meaning ? Are they any different from an investor who holds an large stake ?

Thanks for your excellent blog.

Posted by: Vivek Rajan | Oct 4, 2005 9:32:55 PM

Interesting. I believe that there is another point to be made here, or another caveat. Even if founders seek legal assistance that clearly lays out who is entitled to reap the benefits of a startup, founders may still find themselves subject to the jilted "founder" claims. As the Disney case established, even in the absence of a non-disclosure agreement, idea theft is actionable. So, while founders who have done all they can to protect their rights vis-a-vis the founding group, should they have originated from another and had reason to know that those conversations were confidential, I am under the impression that even jilted founders have rights in the startup.

Posted by: David | Oct 19, 2005 3:43:04 PM

I found this post really interesting. My startup has faced these exact same questions. I'd be interested to see your responses to some of the questions commented on this post.

Posted by: Matthew Sederberg | Nov 18, 2005 2:13:46 PM

"The Forgotten Founder" caused me to chuckle, more than once. Thanks for that. We deal with about 1200 entrepreneurs annually, in our business as finance intermediaries. We end up representing about 50 of those and, to a person (or team), they all flail endlessly at the concept of the "Glacial VC." What they fail to understand is that most VC's are beholden to their LP's....hence, the careful movement. They all have a deal that's "the next best thing to sliced bread," and they all get a dose of reality over time. Some make it - very few - most don't. Kudos to the real entrepreneurs, eh? The ones who can face battle and adapt as need be are the ones we love to work with. Thanks for the Blog; nice to see.

Chris

Christopher S. Hintz
Chief Executive Officer
VC Intermediary, LLC
Bridging The Gap Between Qualified Companies and Capital Resources
www.vcintermediary.com

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Posted by: Chris Hintz | Dec 4, 2005 6:35:38 PM

I've had 35 years of start-up experience. Every CEO should know basic legal issues; and also know that a little knowledge can be dangerous.

If a start-up team starts to take notes to protect each person's founder status, we have a problem that is far more serious. The start-up will fail.

Further, when the board discusses the fair-share for a founder whom they feel is no longer contributing, it sends a negative signal that demotivates all the employees.

It's far more important for the founders and the board to build teamwork and trust that leads to constructive problem solving. That leads to shareholder value for all participants.

I respective disagree with the advice; and warn entrepreneurs to look for these symptoms as a sign of deeper problems.

Posted by: Dash Chang | Dec 7, 2005 9:11:31 PM

This is a very interesting discussion and thanks to all of you for that. My personal view is that founders and their personal dynamics come in so many flavors that its almost impossible to prescribe a generic formula for when and how to structure a legal arrangement to protect the interests of everyone involved. I agree with Daniel Howard's comments that if you over-do the "legal stuff", chances are the start idea won't get anywhere!

The truth in my opinion is that you have to try, possibly get burnt and then learn from the process. If things work out for you the first time around, consider yourself extremely lucky!

Posted by: Pran | Jan 30, 2006 6:08:03 PM

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Posted by: Nick | Apr 3, 2006 8:08:05 PM

A really interesting post. From a UK perspective I doubt many start ups consider these issues. There is also a good commercial reason for not spreading the team too widely in the initial stages; which is that the whole project can become too familiar to the local business and funding community. Think of the scenario, there is good reason while bootstrapping to get lots of supporters and helpers, but if this means that every VC in town has heard of you before you go to raise funds, and wonders why you have made so little progress it won't help. Of course there is a real tension here between keeping you powder dry, and on the one hand bootstrapping what support is to be had, and book building with the VCs/business angels. I guess like all things its about moderation.

Posted by: Lake Falconer | May 2, 2006 3:03:54 AM

Nice and very ... true ! We faced every single fact on this post.
Contrary to other comments, I really do think that structuring the team (teamwork, responsibility and tasks), the company (not that difficult, not that long) and finding a good not expensive lawyer (everybody knows someone who knows someone who's father has a good lawyer friend) are KEY TO SUCCESS for leading an idea to life without cutting the throat of your partners with a rusty spoon IN THE CASE there are several founders.
What about a solution solution to the problem fixing equity on a democratic way: instead of the exclusion clause in the shareholder agreement, instead of reducing the share of a founder to its "fair-share", founders could define a potential equity for everyone in the team, but also tasks and responsibilities. This "potential" equity could consist of a core share and a bonus share. Every three months a review would be done to increase (or not) the core share. No one is favourably or unfavorably treated as it is a board decision. Shares could be fixed the day the team knocks at the VC door.
My 2 cents....

Posted by: Laurent | May 3, 2006 8:26:48 AM

Do you (or anyone) have any advice for a departing co-founder who has invested some of his own personal money and who also has a good chunk of his common stock vested already (but just a handshake - no agreements signed yet)(more than a year has passed). The company is presently looking for additional investors.
Thanks,
Doug

Posted by: Doug | May 17, 2006 11:18:17 AM

I am an intellectual property lawyer and your comment that the "really good" lawyers will work a deferred or discounted basis is should be taken with a grain of salt. This may have been true in the dot.com days when lawyers could get compensated through a grant of equity in a start-up, but not now. In fact, I think you should be careful in selecting a lawyer who is too eager to work for discount rates, especially if there's nothing in it for them -- they may be taking your case out of desperation.

I would recommend interviewing several lawyers and choosing the one with whom you feel most comfortable. The lawyer-client relationship is very personal, so in addition to competence, you should select someone you like, trust and with whom you can work shoulder-to-shoulder -- not the one who charges the lowest rate.

Remember, even with legal services, you get what you pay for. Caveat Emptor!

Posted by: Suzi | Aug 16, 2006 6:19:33 AM

thankyou

Posted by: sohbet | May 7, 2007 3:48:18 AM

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Posted by: sohbet | May 7, 2007 4:22:31 AM

thank you

Posted by: chat | May 7, 2007 4:50:18 AM

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Posted by: sohbet | May 7, 2007 4:53:49 AM

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