How to avoid being left out of the startup that you established

How to avoid being left out of the startup that you established

October 16, 2019

Steve Jobs, the brilliant mind behind Apple, who founded the company from his parents’ garage, was removed from his position in the company in 1985. In a 2005 speech at the Stanford University, he was quoted saying: “How can you get fired from a company you started?” But Steve Jobs is not alone in the “club” of entrepreneurs who were ousted from a company they started and, sometimes, proper legal drafting can prevent this in advance.

The proper way to set the relationship between company founders and prevent future disputes among them or jeopradizing their rights is by a “founders agreement” that predefines the company’s operation and the parties’ rights therein, or at least articles of association that are duly drafted to that effect. Such a document must be prepared by an attorney with extensive business experience in order to prevent a situation where the agreement will block future investments in the company or where the investor demands, as a prerequisite to its investment, the cancellation of such agreement. It must also anticipate the possibility of a shift in the balance of control in the company and a possible dispute between the entrepreneurs. A possible scenario for a shift in control, detrimental to the founder, may include fraud by one of the other founders, a situation where one of the founders simply chooses to cease investing time and money in the company or where there is a dispute between the founders, leading to one of them being ousted from the company. Thus, for example, in a case heard at the Tel Aviv Court in September 2019, three entrepreneurs founded a startup company and signed an agreement by which their shares are subject to a vesting period, whereby the company may buy back shares from any of them whose employment was terminated and any two of them may terminate the employment of the third. Three months later, one of them found himself out of the company and the Court validated the mechanism so that the entrepreneur found himself out of the company he founded. Conversely, in a holding given one month earlier, a Court cancelled a document signed by an entrepreneur in which he waived his shares. However, the outcome could have just as easily been different in that case too.

A founders agreement must enable proper company management and should contain the matters that parties see as important. For example, capital distribution among the founders may be based on monetary investment, time investment or other demand that each founder must comply with. Drafting of the document must take into account tax considerations, it need be drafted in a manner that does not deter future investors and, above all, it must not, by itself, lead to disputes between the parties due to unclear language. Therefore, it is important that the document be prepared by a lawyer experienced in mergers and acquisitions, becasue saving money at this stage, might cost a great deal in the future.