If you have built a business, you know what it feels like to start a meeting with a friend, or a colleague with whom you have established a meaningful relationship, knowing that it is 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. You will know in your gut that the issue is rapidly approaching and whenever you start such meetings in your business lifecycle, they are tough.
Your business success depends on your team, and you should deal with the issue sooner rather than later as you will not be the only one who has spotted the problem. Here is how to get through it and, hopefully, with your relationship intact.
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’.
When operational reality kicks-in and there is need for professional sales, orderly books, 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.
If you already have customers and a proven product and are planning to secure venture capital funding or scaleup, you may have to face the fact that not all of your senior team are going to make the transition.
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.
The real secret is not to make any promises early on and especially not as regards equity, but that is easy to say being a former venture capital lawyer. Assuming it is too late for that, the tenor of your meeting and the outcome will be decided by:
how the relationship has been managed,
the extent of any expectation gap,
the legal structure; and
your culture and approach to people.
Let’s take each in turn.
An open and honest relationship will typically mean that everyone knew it was coming ahead of time and that the possibility of his or her exit from the business was understood. Also, 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 why 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, but it will be short-lived. What few realise at the time is that experience in a startup or a high growth scaleup provides them with valuable and transferable skills to seek new opportunities in similar organisations.
Reality has to be explained and the contractual reality is your starting point. You have to be firm and at the meeting explain, subject to contract and perhaps 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 your best man.
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.
Was the discussions over pizza at 3am about the leaver receiving 5% or 10% or was it never really firmed up? Was the holding a fully diluted one? Was the percentage discussed before or after the seed round? 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 some 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 an amount verbally agreed in lieu of payment for work done.
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 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. I have experienced senior employees taking a salary while obviously spending their time setting up their own business, even a couple who spent the entire day, every day, romantically engaged in the toilet or car park. Others have become stressed after realising that they don’t have the skills required, but don’t want to leave the business. Some involved in startups were just completely useless. However, everyone should still be treated with respect, even when they are shouting at you. Turning a difficult situation into a legal argument is rarely a good use of a founders time, and your board and investors will recognise that.
Ideally, you should hire the right people from the outset and look beyond your immediate network, but it is rarely that straightforward. If you start a business or plan to grow the one you have, one day you will have to fire or make somebody you consider to be a friend redundant. You are on a decade-long voyage, and it doesn’t make sense to let someone head back to shore with a big share of the upside for helpfully untying a difficult knot to free your ship from the harbour wall.
Even if they are your spouse's best friend.