I have attended several recent events and had conversations with entrepreneurs thinking of starting a business or in the process of scaling up new businesses. I have been asked, “should I find a co-founder” and “how much equity should I issue to my new hires”. I have spoken to friends who are starting a business - one has left to focus on the business and the other was "waiting for the right time to leave their job." So I thought I would share some experience about how to fire your friend.
Call it cold, but, it’s important and can save you a lot of time, emotional energy, pain and money. This is a version of an article on my web site blog: https://www.pierslinney.com/blog
It can be frustrating and expensive to spend decades building a business and having to buy out a co-founder who left after a few years for a material amount of money. A case in point - the co-founder of moneysupermarket had to buy out his cofounder for over £160 million in 2007. They founded the company in 1998 and his partner left in 2002 after they "fell out". The remaining co-founder sold his last shares in the company in 2016 – 9 years later.
It is tough to start a meeting with a friend, or a colleague with whom you have established a meaningful relationship, knowing that it's time to part company. Such a meeting may occur very soon after the dust of the startup chaos has settled, or after several years as more complicated operations demand specific skill-sets and experience instead of energetic multi-tasking and learning on the job. The startup phase can be a chaotic and frenzied time when there is so much to do without the necessary resources. It is natural to call on friends, family and the neighbour in between marketing jobs to help and people can find themselves covering several roles, some of which are completely new to them. When you incorporate, you may feel pressure to issue shares, or ‘sweat equity’ to your ragtag team of volunteers because they may have worked for free and ‘added value’. If you have been to University, you may recall making much sought-after new friends during the first week and then spending the next 3 years trying to avoid most of them.
When scaling up, operational effectiveness is key as are the skills necessary to enable growth with minimal risk. Investors will expect this and will look for it during diligence. There is need for professional sales, orderly financial management, experienced project management, or a ramp up in the complexity of your software development programme - the pressure to deliver can strain relationships. Some people evolve with businesses and can go all the way, while others struggle.I have built several businesses that have required several management refreshes. By the time revenues are in the millions you will have developed strong relationships. Often, the writing has been appearing on the proverbial wall for some time, but the issue has not been discussed openly because there is always an excuse to avoid it. But, eventually, the day for that meeting will come and you have to deal with it.
Here is some advice based on my experiences.
An open, honest and properly managed relationship will typically mean that everyone knew it was coming ahead of time. You are both an employer and a friend. The former has to follow the rules, while the friend can meet for a frank chat at the weekend. An open approach to communications should be a cultural pillar in any business, especially one experiencing constant change. You should manage everyone properly from the outset, but few entrepreneurs do and they all have tales about how they lived to regret it.
In my personal experience, such meetings provide the leaver with relief from the uncertainty and awkward conversations about the need for skills they don’t possess, and results they can’t deliver. The meeting then becomes a discussion about a fair exit structure taking into account their contribution and the progress of the business. However, expectation gaps can arise leading to the wheels spinning off in all directions.
Bridging Expectation Gaps
A leaver who was there in your kitchen sharing coffee making duties and pizza late into the night while mulling over the design of your product or service may have already developed premature visions of selling out and enjoying, at least, a mortgage-free life. Having the rug pulled away from beneath them and suddenly contemplating a return to corporate life, can lead to friction.
Reality has to be explained, and the contractual reality is your starting point. You have to be firm and explain, subject to contract and perhaps investor consent, a fair and affordable deal for the business and how you have come to it. You may have to explain why they will leave with no equity or options or with a small payment for their single digit holding. Investors will not want you to part with any more than is necessary, even if the leaver was the best man at your wedding.
The Legal Structure
Promises of equity and options that have not been put into writing compound leaver discussions and a lack of legal clarity leads to potentially expensive ambiguity. Even if your business is well-structured and you have put in place detailed constitutional documents and a shareholder agreement, do you really know what happens when a shareholder-employee leaves your business?
Even if options lapse when somebody leaves, or equity has yet to vest, they may ask to retain a stake to compensate for those late nights in your kitchen. If they are classified as a good leaver in a shareholder agreement, their shares may have to be repurchased at market value. What is the market value? Should an aggressive minority discount be applied and are your investors going to be happy that funds are being used to buy out the minority stakes of the team you sold to them? Did the leaver pay for the shares, or was it sweat equity?
Things can go awry very quickly, so you have to know the legal position and protect the value for the ongoing stakeholders as it may be ten years, or more, before value is realised. This actually applies amongst founders too – equity and options have to be carefully structured.
I have run businesses facing constant change and have been through many reorganisations where great people have not made it to the other side. Some left with no upside and some left with life-changing pay-outs. People are fundamental to success, as is your culture. How you treat those that no longer have a role says a lot about you and your business to ongoing employees and other stakeholders. I have had to make friends and even mentees redundant. We are still friends.
Everyone should still be treated with respect, even when they are shouting at you.
You are on a decade-long voyage. It doesn’t make sense to let someone head back to shore, before you have even left the harbour, with a big share of the upside for helpfully untying a difficult mooring knot.
Even if they are your spouse's best friend.