What can co-founders do for mutual protection?

(This was my response to a question on Quora.. which was qualified with the following additional comments by the person asking the question:

Hi,

We are 4 guys starting a new company, and we are looking to formalize an agreement that will:

1) Protect all of the co-founders from a non-performing co-founder.
2) Protect a co-founder from being kicked out by the majority of the co-founders without any justified reason.

We’re specifically talking about clauses like vesting, cliff, voting rights on how to fire one of us, etc.

What would be a good mechanism to achieve this?)

My response

Apart from legal contracts and vesting, which of course need to be there, my view is that entrepreneurs need to have a detailed discussion among themselves on a number of what-if scenarios.

I ask my startups to think and debate and discuss about some of the following scenarios and points:

  • Agree on what ‘success’ means- typically, when numbers are not discussed  and founders go on the basis of passion, the underlying understanding (even if not stated) is that this will be a ‘large’ business. I therefore ask the founders to write down separately what they see as their revenues in 5 years time. Often, there is a 5 – 10x difference between the numbers quoted by two different founders. One founder’s view of ‘large’ is USD 10 million, while the other aspires to be a USD 100mn brand in 5 years time. Obviously, with such differences, the founders satisfaction from the traction is likely to be different, and, in this particular example, even if the company were to be USD 30 mn in revenues in 5 years, we would end up with one disgruntled and dissatisfied founder.
  • What if someone were to buy you out for USD 10 mn in 1 year’s time? (often all founders say yes, we will sell)… then I ask what if that number was USD 2 million and not 10.. often at least one of them says he/she will sell out (this person is usually the one who has the least faith in the potential of the business, and hence as a mentor my goal is to help the person see the potential… or understand from him/her why he/she has that perception)
  • How much time can they go without a salary in case the story does not play out as planned. Different people will have different answers based on their circumstances… and that’s OK. Just that the rest need to be aware of the choices that the person will make in case of crunch situations.
  • How do you handle failure? Will you penalize a founder if he/she does not deliver? Will you be tolerant, supportive and inclusive in case one of them under performs? My view is that often someone will under deliver or fail in their deliverables… and that’s ok AS LONG AS THEIR COMMITMENT AND EFFORT WAS 100%. But that’s just my view. Founders have to decide how they will deal with incompetence or failure. In many cases, founders take on responsibilities based on their perceived areas of interest or what the situation needs them to take ownership of. In most cases where there is no prior experience or interest, this is stressful. My view is that founders need to give each other the space to fail, with adequate processes for early warning signs and course corrections. Of course, this applies if the commitment was 100%, the attempt was honest and there were no integrity issues.
  • What happens if one of the founder becomes incapable of performing his/her duties (accident, family circumstances which require him/her to shift to another city, if the startup changes the business model or the concept, etc.). Will he/she continue to get the same privileges, equity and salary as was originally agreed. (there is no right or wrong answer. Founders have to collectively take a philosophical call on these type of issues. Well, to push the point, they also should discuss what will happen to the person’s shares in case he/she were to die… would the shares go to the family or to the founders or go back into an ESOPs pool?)

There are a lot of things that founders should agree on BEFORE starting up. And often these things are not discussed. They should be. If there is prior understanding on who will make what choices under what circumstances, the friction & stress can be avoided (or at least reduced).

Additionally, the founders NEED to decide who the CEO will be (and why) in case the team gets funded. (Lack of agreement on this, and multiple founders with similar aspirations can be a sure shot disaster).

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