What Happens When a Co-Founder Leaves the Company?
When a company is founded, the focus is almost always on the opportunities ahead. The founders share a vision, work towards common goals and devote all their energy to developing the business. Considerably less attention is paid to the question of what happens if one of the founders chooses, or is forced, to leave the company.
The short answer is that a co-founder does not automatically lose their shares when leaving the company. Instead, what happens depends on the shareholders’ agreement, any other agreements between the parties and the circumstances of the particular case. In addition, issues relating to corporate governance, trade secrets and the continued operation of the business often arise.
In practice, however, this is a situation that many companies will face sooner or later. Personal circumstances change, priorities shift, and working relationships that functioned well during the start-up phase can become more strained as the business grows. Planning for such a departure is therefore not a sign of distrust, but an important part of building a well-governed company.
A Departure Affects More Than Ownership
When a co-founder leaves, the issue rarely concerns ownership of the shares alone. A founder is often a key individual who fulfils several roles simultaneously. The person may be an employee, a board member, an authorised signatory, the head of product development or the individual responsible for the company’s most important customer relationships. In smaller companies, knowledge and responsibilities are often concentrated in the hands of only a few people.
If a founder leaves without a clear plan in place, the company may therefore face significant operational challenges. Projects may stall, customer relationships may be affected, and the remaining shareholders may need to assume additional responsibilities at short notice. Investors and lenders may also react if a key individual leaves the business, particularly if the reasons are unclear or the process is marked by conflict.
What Happens to the Shares When a Co-Founder Leaves?
Perhaps the most frequently discussed issue concerns the departing founder’s shares. From a legal perspective, there is no general rule providing that shares must automatically be sold back to the company or the remaining shareholders when someone ceases to work in the business. The starting point is that the shareholder retains ownership of their shares even if they no longer contribute to the company’s operations.
This can give rise to several practical issues. The former founder may still have voting rights at shareholders’ meetings, be entitled to dividends and retain the ability to influence important decisions. For the remaining shareholders, it may be problematic if someone who no longer contributes operationally or shares the ongoing business risk continues to hold a significant ownership interest.
At the same time, it may be unreasonable to require the departing founder to sell their shares without fair compensation, particularly if they have helped build the company’s value over many years. For that reason, it is important to agree from the outset on the rules that will apply.
The situation often becomes particularly complicated if the departing founder holds a substantial shareholding or if the company has several shareholders with differing interests. In such cases, a founder’s departure may affect both the company’s decision-making processes and its ability to attract future investment or implement other strategic changes.
What Happens If There Is No Shareholders’ Agreement?
It is not uncommon for companies to be established without a shareholders’ agreement. During the early stages, the focus is often on developing the business, while questions relating to a possible future departure are postponed. It is often only when a founder wishes to leave the company that the consequences of not having clear agreements in place become apparent.
If the shareholders have not regulated the matter in advance, there is generally no obligation for the departing founder to sell their shares. As a result, the individual may remain a shareholder even though their operational role has come to an end. For the remaining shareholders, this may mean that a former co-founder continues to influence important decisions and remains entitled to benefit from the company’s future increase in value.
How such a situation should be managed depends on a number of factors, including the company’s ownership structure, the stage of development of the business and any other agreements between the shareholders. For that reason, it is often considerably easier to regulate these issues before they arise than once a conflict has already developed.
The Shareholders’ Agreement Is Often Decisive
A well-drafted shareholders’ agreement is one of the most important tools for preventing disputes when a co-founder leaves the company. Many shareholders’ agreements include so-called Good Leaver and Bad Leaver provisions, under which different rules may apply depending on the circumstances in which a founder leaves the company. How such provisions should be drafted depends on the specific circumstances of the business and is discussed in more detail in our article on shareholders’ agreements.
Valuation Can Become a Source of Dispute
Even where all shareholders agree that the shares should be transferred, the next question often arises: what are the shares actually worth?
In early-stage growth companies, this can be particularly difficult to assess. The company may not yet be profitable but may nevertheless have significant future potential. The founders may therefore have very different views as to the company’s value, making valuation one of the most common causes of disputes.
How a company should be valued depends, among other things, on its stage of development, its financial circumstances and the agreements that exist between the shareholders. For that reason, valuation often becomes one of the most debated aspects of a founder’s departure.
To avoid lengthy discussions, many shareholders choose to specify in the shareholders’ agreement how the valuation is to be carried out, who will perform it and the principles that will apply. For that reason, valuation often becomes a key issue when a founder leaves the company and should be considered in light of the company’s specific circumstances.
Competition and Trade Secrets
When a founder leaves, they often take valuable knowledge, experience and professional networks with them. The company therefore has a legitimate interest in protecting its trade secrets and ensuring that confidential information is not used in a competing business.
Confidentiality obligations often continue to apply even after the collaboration has ended. However, if the company wishes to restrict a former founder from establishing or working for a competing business, this will generally require specific non-compete provisions. Such provisions must be reasonable in terms of both scope and duration in order to be enforceable.
Common Disputes When a Co-Founder Leaves
Not all disputes concern the value of the shares. In practice, disagreements often arise because several issues need to be resolved at the same time, while the relationship between the founders may already have become strained.
Common areas of disagreement include ownership of intellectual property, such as software, trademarks or other material developed during the company’s growth, whether the former founder may approach the company’s customers or employees, and how ongoing projects and customer relationships should be handed over.
The more of these issues that have been regulated in advance, the greater the likelihood that a founder’s departure can be managed without adversely affecting the business.
Practical Matters Are Often Overlooked
In addition to the legal issues, a number of practical matters also need to be addressed. Access to bank accounts, accounting systems, customer databases and digital services may need to be revoked or transferred. Authorised signatory rights and board appointments may need to be updated, and customers or suppliers may need to be informed of who their new point of contact will be.
The more structured the transition, the less disruption there is to the company’s day-to-day operations.
Prevent Disputes Before They Arise
Most disputes between co-founders are not caused by the law itself, but by the parties having different expectations. The departing founder may feel that their contribution has been undervalued, while the remaining founders may consider it unreasonable for someone to retain a significant ownership interest without continuing to contribute to the business.
By discussing these issues when the company is first established, it becomes considerably easier to manage a future departure. Clear agreements cannot eliminate every dispute, but they provide a common framework when difficult decisions need to be made.
How Are Investors and Future Financing Affected?
For companies planning to raise external capital, the departure of a co-founder may have consequences that extend beyond the immediate change in ownership. Investors often attach significant importance to a stable ownership structure and clear procedures for managing changes within the shareholder group.
A well-managed departure demonstrates that the company is capable of handling change in a commercially sound manner. Conversely, if the process is characterised by uncertainty or disputes, it may raise concerns regarding the company’s governance and long-term stability.
Summary
The departure of a co-founder is often both an emotional and business-critical event. How successfully the company manages the transition depends to a large extent on the preparations made before the situation arises. A well-drafted shareholders’ agreement, clear rules governing share transfers and a plan for addressing both the legal and practical issues reduce the risk of costly disputes and enable the business to continue developing, even as its ownership structure changes.
How Can Forsety Legal Help?
Whether you are looking to prevent future disputes or are already facing a situation where a co-founder is leaving the company, obtaining legal advice at an early stage can make a significant difference.
At Forsety Legal, we assist entrepreneurs and companies with ownership changes, share transfers, negotiations between shareholders and other corporate law matters. Our advice is always tailored to the company’s business, ownership structure and commercial objectives, with the aim of finding solutions that are both legally robust and commercially sound. Our ambition is not only to provide legally sustainable solutions, but also solutions that work in practice and enable the company to continue developing with a stable and well-defined ownership structure
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