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Start-up and tech founder disputes become more common when a business starts to smell success: tips to avoid litigation

 

It’s all too common a news headline that the founders of a burgeoning start-up, that is gaining market share and recognition, have raised a large amount of capital in return for debt or equity in the business – only for the founders to end up in a heated dispute either between themselves or with the investor.

Quick growth in a business and market recognition can lead to small (and often under-resourced) start-ups in any industry looking for a deep-pocketed partner to provide an injection of cash to fund the business aspirations. The investors will necessarily want a large stake of the shares, commensurate with their investment, and will seek representation on the board and/or an executive director to be employed in the management of the company.

The investor’s agenda for the growth and development of the company will at some point diverge from the founders’ views or approach. This is when issues can arise as to which direction the company should take and can lead to machinations as to who is invited to meetings, who is provided with certain information on proposed plans or the progress of targets and implementation of strategies.

Time and time again, this can be seen to develop into a marginalisation of one (or all) founders and coercion for them to be less involved in the decision making and management of the company. Such conduct can be used to force the founders to sell their shares or the investor may use enforcement action pursuant to a breach of conditions of the investor’s financing. This is when founders can rightfully begin to feel disgruntled and unfairly treated, leading to disputes which can cause as much harm to the business as they do to the marginalised founder/s.

How can founder/shareholder disputes be prevented?
  1. Ensure that the articles of association include a dispute resolution mechanism between shareholders, in the event of serious disagreements arising. It is often helpful to include referral to a mediator, chosen by the relevant law society, so the selection of the mediator is independent.
  2. The articles of association should also include a share valuation methodology to be applied to value the shares at any given time. This can prevent the need to argue over what valuation methodology should be applied, in the event one shareholder wishes to sell/buy shares from the other or if a dispute arises.
  3. Attempt to address any disagreements in vision or strategy for growth internally. Communication is key and if applicable/appropriate, use an in-house counsel or more neutral manager to mediate the issues, so that the disagreement doesn’t escalate or lead to embittered positions.

If dispute resolution attempts are unsuccessful and it is necessary for a founder to commence legal action, contact Chris Martin or a member of our team of litigation funding experts.

Interested in learning more about the topics raised in this blog?

Check out the next blog in this series – “Founder’s feuds – Unfair prejudice claims and how litigation finance can help”.

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