Can I Kick Out a Co-Founder
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Can I Fire My Co-Founder Who Has More Equity?
Cofounders of a company generally establish their ownership percentage very early in the relationship. Without a formal relationship, the default rule is that all founders are equal owners of the company. This can result in impasse when the company owners are unable to reach agreement on business matters. As such, it is advisable for one founder to have more equity or express decision-making authority with regard to specific matters. This can avoid the possibility of impasse. This, however, brings up the question of what happens when the parties cannot come to agreement? Can one co-founder (who has a higher equity ownership percentage) fire or kick another co-founder out of the business?
This article examines these questions in the context of various entity forms and ownership scenarios.
Kicking Out a Co-Founder
What happens when two owners of a business cannot get along? What if one owner wants to kick the other out of the business? Can this happen and, if so, how?
• General Partnership - The default rule in a general partnership is that, if one party leave the partnership, it dissolves. If the business is still operational, the parties are required to wind up operations. This means distributing the resulting value to each partner. In reality, this scenario does not meet the needs or desires of either partner. In most cases, the parties are forced to negotiate a scenario where one party buys out the other party and then continues business operations. The default partnership rule can be changed by adding a “buy-sell” provision to the partnership agreement or constructing a separate buy-sell agreement that is signed by the partners. The buy-sell agreement should deal with the scenario of what happens if one party wishes to leave the partnership. It generally establishes a process for buying out one party and allowing the remaining partners to continue operations. In summary, simply having a larger ownership percentage in the partnership does not allow the partner to kick out other partners.
• Limited Liability Company (LLC) - The owners of an LLC are called members. The default rule in most states is that the LLC does not dissolve when one LLC member wishes to separate from the business. There is generally some form of equitable split between the parties of company value. This leaves the remaining members to continue company operations. Unfortunately, the default rules do not provide a method for valuing the company. As such, the company will often fail as a result of extended legal arguments between the parties. Again, it is highly advisable to have a buy-sell agreement in place to deal with these situations.
• Corporation - A corporation has a very formalized ownership structure. The shareholders vote for directors. The directors hire the officers to manage the daily affairs. If a shareholder holds a controlling interest in the corporation, she may be able to elect a majority of the company directors. Note: Most companies have voting procedures in place to limit the authority of a majority shareholder. For example, the company may have cumulative voting rules and staggered voting schedules to diminish the voting power of individual shareholders. In any event, if the controlling shareholder is able to elect a majority of board members, those board members would then be able to designate the chairman of the board and company executives. This could effectively wrestle control of management and decision-making away from a co-owner or co-founders. While this may have the effect of centralizing control, it does not result in expelling the other shareholder from the company. Further, the other shareholder generally has the right to force the company to approve her sale of her ownership interest or repurchase her interest. In the latter scenario, this would have the ultimate effect of pushing the co-owner out of the company.
In summary, it is very difficult to push out a company co-owner of co-founder. It normally can only happen by buying out the other party’s interests. In any event, it often has such a negative effect upon operations that the company suffers as a result.