Inactive co-founder holds 33% but refuses to dilute
We are 3 founders in the business. The two are working as close to full-time as we can given we dont receive a salary, we each hold 44% and 23% which leaves the last partner with 33%. He has been very inactive, partly due to contracting a severe disease (lymes) and has not been able to provide what we expected of him when we started.
The terms under which we started was that he funded the business for initial expenses which were about $60k as well as keeping the business afloat while he would actively use his connections as a former Goldman sachs employee working in VC. He would also assume position as CFO although not full-time.
We're slowly running out of money as he is not interested in adding more funds in the business as well as not actively participating in finding other sources of capital.
The two partners (myself and my partner) have been actively building the business for 1.5 yrs and have provided almost full-time sweat equity.
We have been speaking to advisors and potential investors but the immediate reaction is that the partner holds too much stock compared to his commitment and there is no interest in joining since the terms are unreasonable. What I have gathered from that is that we are overvalued, and poorly structured, which is also what we've been told.
The question is: How do we continue forward, if we cannot come to an agreement with the 3rd partner? How to restructure a company after the fact that we've been building for over 1 year. There is an operating agreement, which was provided by partner 3's attorneys, and I'm waiting to read it through thouroughly. Do we have an option to either buy him out or dilute his shares somehow. I'd prefer a fair resolution, but so far he has not acted in a reasonable way. We're quite at a loss, and not sure what to do...
Equity Finance Startup Costs Entrepreneurs
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You have to read your Operating Agreement to find out what your options are in terms of buying him out. If there's something in your Operating Agreement you don't understand, we would be happy to help you with that. But spending our time speculating about what may or may not be in your OA is not very useful. Also, it's not clear how your company is structured. Operating Agreement implies LLC, but "shares" implies corporation. – Zuly Gonzalez 12 years ago
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$60k is a lot of money. Have you offered him a buyout? I don't think I would give up equity that easily if i invested that much money in a company either. – Tim J 12 years ago
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In addition to operating agreement, you should look at resolution of who owns what you have done after you fold because that's where it seems to be headed. – Karlson 12 years ago
1 Answer
If he is a shareholder... there are limits to what you can do... and what you can do is solely dependent on how your operating agreement is constructed. Get a lawyer to review your specific agreement!
If the operating agreement is fairly standard (I suspect this to be the case), then you are not going to be able to force a buy-out unless he agrees to the terms. If the operating agreement allows for voting based on the # of shares held, then I see no reason why you couldn't open the business up for a financing round at a comparable valuation to before, and then the partners (excluding the trouble partner) would fund the business and he would suffer dilution as a result of the raise. Over time, as you do successive raises internally he will continue be diluted down.
But again, always smart to talk to a lawyer. I don't do anything, especially when it comes to shareholder issues, without out. This is not an area to cheap out.
