Startup Legal Lessons from the Biography of Steve Jobs (Part 2)
With the movie “Jobs” opening in theaters this week, we are taking a look at the startup legal lessons raised in Walter Isaacson’s bestselling biography on Steve Jobs. Not surprisingly, given the dynamic history of the company Jobs co-founded and led, the book touches upon numerous legal issues encountered by Apple. These legal issues, as presented in Isaacson’s book, serve as a useful framework for addressing some of the common legal issues faced by startups and entrepreneurs today. This is Part 2 of a multi-part series.
This post discusses the scenario of a departing founder. As explained on page 61 of Isaacson’s biography, within two weeks of organizing Apple, co-founder Ron Wayne made the decision to leave the company. He sold the entirety of his partnership interest to the other co-founders, Steve Jobs and Steve Wozniak. Ron Wayne’s motivation to leave Apple was in part due to the personal liability he would take on as a partner in a general partnership (as discussed in Part 1 of this series, Apple was originally organized as a general partnership).
The departure of a startup founder, however, may not always go so smoothly. It is extremely common for founders to leave startups. All too often, these founder breakups can be fatal to a startup. According to Harvard Business School Professor Noam Wasserman, roughly 65% of the failures of high-potential startups are due to “people problems.”
There are well-known mechanisms, however, that make it possible for a startup to survive a founder breakup. These include:
All individuals working for a startup should sign documents assigning to the company any intellectual property created by that individual arising from their work for the company. This is typically accomplished through a Proprietary Information & Invention Assignment Agreement (commonly called a PIIA). This document should be signed by an individual at the beginning of that individual’s relationship with the startup. Proper IP assignment language should include the words “hereby assigns,” so that the language will act to automatically transfer IP rights from the individual to the company upon the individual creating that IP.
If the individual has created IP related to the startup’s business prior to entering a formal relationship with the startup (such as a founder who has been working on an idea prior to incorporation), then that individual should also assign to the company that individual’s IP rights already in existence.
Restricted Stock Agreements Implementing Vesting
As discussed in this prior post, vesting refers to a company having the right to repurchase an individual’s equity if that individual’s service terminates. The company’s repurchase option lapses over time. Vesting is typically implemented through a Restricted Stock Purchase Agreement (for a corporation) or a Restricted Unit Agreement (for an LLC).
Departing Founder Example
Let’s pretend Departing Founder owns 25% of the common stock in a startup. Departing Founder has a falling out with his or her co-founders. Departing Founder has not signed any documents assigning IP to the startup and does not have a vesting schedule in place covering his or her common stock. Upon Departing Founder leaving the startup, her or she will likely walk away with (at least) joint ownership of any IP to which Departing Founder contributed, and the full 25% of the company’s common stock. The startup will not have any exclusive rights to the IP jointly-owned with Departing Founder. In addition, 25% of the company will be dead weight, which will certainly be demoralizing to the remaining team members still working for the startup. This startup is likely doomed unless it can work out an agreement with the Departing Founder to claw back the IP and equity.
Now let’s pretend the same situation exists with Departing Founder except that proper IP assignments and vesting schedules are in place. Upon Departing Founder leaving, all IP will remain with the startup. The Departing Founder walks away with no rights in the startup’s core IP. Additionally, the startup will have the right to repurchase the unvested portion of Departing Founder’s 25% of the common stock. For example, if vesting occurred over 4 years with a 1-year cliff, and Departing Founder left just after the 1-year mark, the startup would be able to automatically repurchase 3/4 of the common stock held by Departing Founder. Departing Founder would remain a shareholder of the company, but only for the 6.25% of vested common stock (1/4 of Departing Founder’s 25% of the company). The repurchased common stock would return to the company’s pool of authorized but unissued stock. It would be available to incentivize the remaining workers, or more likely to attract the talent needed to replace Departing Founder.
Release and Termination
If possible, it is also wise to enter into a release and termination agreement with a departing founder. While Ron Wayne is at peace with the fortune he would have had he not left the company, other departing founders might experience seller’s remorse and make claims against a company whose value skyrockets after a founder leaves. Ideally, a startup and departing founder will resolve any possibility that either startup or the departing founder could have any claim against the other in the future.
Returning now to the Apple situation, Ron Wayne desired to return all of his partnership equity to his co-founders. This is likely an anomaly, though. As discussed in our prior post in this series, most startup entities will provide limited liability to founders. Accordingly, most departing founders will not have the threat of unlimited liability (present with a general partnership) to incentivize the departing founder to relinquish their shareholder or member status. With the proper legal documentation — including IP assignments and equity vesting arrangements — startups can survive the departure of a founder.