If Your Co-founder Left, Who Would Own Your Business?

by Startacus Admin

Last week Thomas Taylor a director at Legal Document provider Net Lawman wrote a fab post on why forming a company shouldn’t be a priority when starting a business and this week he returns, this time with a subject that becomes all important should a co-founder leave the business after it's formed. Over to Thomas to explain all...

If you start a business with a co-founder, you’ll do so because you’ll both have enthusiasm for the project and different, valuable skills or assets to bring in. Because those first days are so exciting – brainstorming ideas, developing products and websites, finding the first customers – you’re unlikely to be thinking what happens if one of you exits the business.

Early exit of a co-founder happens more often than most people expect: other commitments get in the way of growing the business; people disagree over direction; promises of time, money or skill input fail to materialise as expected.

And it is only when you consider parting company that you wonder who owns the business you’ve both created. If you haven’t incorporated (and there is good reason not to do so immediately), that can be a difficult question to answer.

You can’t prevent all problems, but you can at least plan for them early on and reduce the impact they have on the business and your life. You need to discuss with your co-founders what would happen in a particular circumstance, and then record your agreement on that in writing.

Under the Partnership Act 1890 (yes, amazingly this Victorian law still applies today), the default legal position is that the business is owned by all founders as equal partners. When one of the partners leaves, all assets and debts should be put under the hammer and the proceeds distributed equally.

It doesn’t matter who put more capital in, had the original idea, gained access to a required piece of machinery to design the prototype, worked longer hours, or has a more valuable skill.

Businesses are rarely created equally. That is where the problem lies for founders. Someone will always feel he contributed that much more than the other. While you are arguing how contributions should be valued, your young business will be neglected.

There is an easy way to circumvent the Act. To get round it, you simply have to sign and date a record in writing (ideally in a partnership agreement, which would also cover other matters relating to how the business will be run) who put what in, and what should happen if any founder exits. For example:

“John invested £2,000 of capital into the business. Joan invested £1,000 of capital into the business. If the business is dissolved before it is incorporated, then all physical assets will be sold and the cash from the sale proceeds and that remaining in the business bank account will be distributed in a ratio of 2:1 to John and Joan in line with capital invested.”

Of course, you might agree different shares based on a measure other than capital investment, such as hours worked. How you decide to divide things does not matter.  You just have to get it in writing.

You should also consider the value of intellectual property. IP in a startup is likely to be designs (including your website content), prototypes and perhaps software that you have written.

Unless you have agreed with the creator of the IP that the IP belongs to the business (again, preferably in writing so that it is hard to dispute your agreement), the law says the creator will remain the owner. If your co-founder is the one who wrote the software or designed the product on which your business relies, unless you have agreed otherwise, that IP is his or hers, and it shouldn’t be considered as part of the assets of the business.

In summary, though it will be the last thing you really want to consider when you are starting, think about how your relationship with your co-founders might end. Record in written agreements who owns what and how the business will be split if someone decides to leave.

About Thomas

Thomas Taylor a director of Net Lawman, an alternative for small and growing businesses to using a solicitor to obtain legal documents. He is a qualified accountant (FCCA, FPA/FIPA).

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Published on: 11th January 2016