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Common Issues in Breaking Up Recently Founded Companies

No one goes into a business venture expecting it to fail, but any number of reasons can cause a recently-founded company to break up. Work styles or personalities may conflict or the founders may discover that they have different visions. You might also find that communication is strained or your co-founder isn’t contributing as much as you think they should.

While no two situations are identical, there are a few common issues that can arise in breaking up recently founded companies, also known as business divorce:

  • The extent to which the partnership or operating agreement governs a breakup — When you or a co-owner start thinking about exiting from the company, it’s essential to review the terms of the agreement you all entered into. A partnership or operating agreement typically contains a separation clause that details what should happen if an owner leaves – voluntarily or otherwise. The agreement may also address vesting of ownership shares and lay down guidelines to buy out a departing owner. If any of these issues are not fully covered, you must implement a method at the time of breakup.
  • Determining each owner’s capital contribution — Co-owners should agree on how to treat each owner’s original cash contribution to the start-up. It may have been in the form of an investment, a loan or a convertible note, the latter being a short-term debt that is paid back in equity as the company grows. The nature of the contribution will factor into deciding on its current value and therefore on the outgoing owner’s compensation.
  • The leaving co-owner’s role in the transition — Often, the departing owner remains on board to ensure a smooth transfer process for the well-being of the company. Start-ups with a founder who stays on until new management takes over have an increased likelihood of success. A method of compensation needs to be worked out, whether the departing owner will be an employee or an independent contractor during the transition. Other issues to address include whether that owner gets to keep equity and receives a severance package.
  • Intellectual property ownership — A start-up’s most valuable asset is often the intellectual property it creates. The key question who owns the IP: Does it stay with the company or the original owners. If the partnership or operating agreement does not fully address ownership rights, the IP must be evaluated and allocated at the time of the breakup.

Even the best-crafted agreements cannot completely prevent or control disputes from arising at the time a company’s co-owners decide to part ways. It may be necessary to engage in mediation or another form of dispute resolution. If all other methods fail, litigation may be required.

Schwartz & Kanyock, LLC has wide experience protecting the legal and financial interests of clients engaged in business divorces. To schedule a consultation at our Chicago office, call us at 312-436-1442 or contact us online.

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