5 potential legal issues with a co-founder

Starting a business with a co-founder can be an exhilarating journey, blending complementary skills, shared visions, and collective ambitions. However, this partnership, like any other, can face its share of challenges. Navigating these challenges successfully often hinges on the foresight to establish clear, legally-binding ground rules from the outset. In the following discussion, we will explore five potential issues that might arise between co-founders and how the proper legal paperwork can serve as a critical tool for conflict resolution and prevention.Cofounder issues- Aerialops

Equity Split Disagreements

One of the most common issues in a startup is how to divide equity between co-founders. 

Disputes over equity ownership can be particularly damaging in a startup environment. Protect your company by formalizing these agreements from the outset.

Co-founders should agree on:

  • The initial equity allocation for each co-founder.
  • A vesting schedule (typically over four years with a one-year cliff) to safeguard the company in case of early founder departure.
  • Other compensation such as salary.

While splitting ownership evenly may seem like a simple solution, it rarely reflects reality. Consider factors like unique skillsets, pre-existing intellectual property contributions, and capital investment when determining equity percentages. Consultation with a legal professional can help you establish a fair and defensible equity structure.

Varied Commitment Levels and Founder Departure

Co-founders often have different levels of commitment and involvement in the business, which can lead to conflicts, particularly if one decides to leave the company. Addressing this requires a legal document with a vesting schedule.

Under a vesting schedule, co-founders earn their equity over time, typically over four years, with a one-year cliff. If a co-founder leaves before completing the vesting period, they forfeit part of their equity. This setup incentivizes long-term commitment and provides a fair protocol for handling departures.

This setup not only incentivizes long-term commitment but also provides a clear, fair, and pre-negotiated protocol for handling departures, thereby protecting the interests of both the company and its dedicated founders

Intellectual Property Disputes

For VC-backed startups, intellectual property (“IP”) is critical, and disputes over its ownership can be devastating. When multiple individuals contribute to IP creation, ownership can become unclear.

Essentially, individual contributions to the business’s intellectual assets should be legally recognized as the property of the business, not the individuals.

An IP Assignment Agreement for each founder ensures any IP created is owned by the company unless it is specifically carved out. This approach prevents conflicts and makes the company more attractive

Decision-Making Deadlocks

Decision-making deadlocks, particularly among co-founders with equal stakes, can paralyze a company. Preventing this requires clear decision-making processes outlined in Operating Agreements (for LLCs) or Bylaws (for corporations).

These documents should include deadlock resolution methods like majority rules, mediation, or external advisors. Granting extra shares to one founder can also prevent deadlocks by avoiding an even vote, ensuring smooth decision-making even in situations where there is initial disagreement.

Navigating Previous Non-Compete Agreements

A less considered but crucial aspect is the impact of pre-existing non-compete agreements. These agreements can limit a co-founder’s ability to engage in certain activities or industries.

Co-founders should disclose any such agreements they are subject to. Structuring the new venture to respect these constraints, and including a Non-Compete Disclosure and Compliance Clause in the Founders’ Agreement, is vital. This clause requires co-founders to operate without violating their non-compete obligations.

Such a clause protects the company by ensuring that all co-founders are transparent about their limitations and committed to adhering to their legal obligations.

A Smart Way to handle Co-founder Issues

Navigating through the complexities of working with a cofounder can shift the focus from core activities, slowing the organization’s growth. Many of these complexities are either primarily legal or can be solved by having the proper legal documentation. This highlights the importance of finding a good lawyer to help properly set equity vesting schedules or secure the right intellectual property assignments.  Just as critically, companies need to keep those legal records organized.  Losing track of a legal document is like not signing it in the first place.  During a compressed fundraising cycle, not being able to find it in time can jeopardize the whole fundraiser. 

Aerial helps founders stay on top of critical legal issues by leveraging AI to automatically organize legal documents. 

For more information, visit Aerial.