Why Founders Dispute Occurs?Preventive Structures and Legal Safeguards
Shilpa Gududur
Shilpa Kiran Gududur has over 23 years of experience. She is a Practicing Company Secretary, Registered Valuer – SFA, and Insolvency Professional. She serves as an Independent Director for a listed company. Her practice areas include Valuation, Corporate Law, FEMA Compliances, IBC and representation before NCLT. She has experience in various industries, including Banking, Construction, and Manufacturing. She was the Compliance Officer of Unnati, the first Section 8 Company to be listed on the NSE Social Stock Exchange.
Introduction
Startups are born out of a shared vision, passion, and mutual trust. But as the business grows, pressure intensifies—on responsibilities, equity, decision-making, direction, finances, and personalities. Conflicts among founders are not a matter of if, but when. Differences in vision, execution pace, equity expectations, responsibilities, or even personality clashes can cause friction. Without a clear legal framework for managing disputes and exits, such conflicts can cripple the business, derail fundraising efforts, or even lead to litigation. It is unfortunately common for founder relationships to sour, sometimes irreparably. The damage from a founder dispute—legal costs, reputational harm, loss of focus, investor backlash—can be existential for a young company.
1. Why Founder Disputes Occur
To manage the risk, you must first understand the fault lines. Common causes of founder disputes include:
a. Ambiguous roles and expectations: Overlaps in duties or confusion about who handles which domain (product, marketing, operations, or finance) breed resentment.
b. Unequal contributions: When one founder feels that they are doing more work (or investing more capital) than the others, yet equity is split equally.
c. Equity and dilution disputes: When new fundraising dilutes founder stakes, or when additional cofounders or key hires are added.
d. Decision-making deadlocks: What happens when two (or more) founders disagree and no tie-breaker mechanism exists?
e. Intellectual Property (IP) disputes: Who owns IP created individually or jointly?
f. Exit or disengagement without process: When a founder wants to step away (temporarily or permanently), but there is no agreed-upon mechanism for how that works.
g. Interpersonal, behavioral, or misconduct issues: Disputes about conduct, violation of trust, or malicious acts.
h. Lack of transparency, information asymmetry: One founder may hide data, profits, or operations from others, leading to suspicion and conflict.
2. Preventive Structures and Legal Safeguards
“An ounce of prevention is worth a pound of cure.” The more you bake in clarity and conflict resolution from the early days, the lower the chance of a nasty showdown. Key tools include:
2.1. Founders’ Agreement
This is a contract among the founding team (often parallel to or embedded in the shareholders’ agreement). It should cover:
a. Roles and responsibilities: Who is CEO, CTO, COO, etc., and what decision rights each has
b. Equity allocation and vesting schedules (including cliffs, acceleration, and forfeiture)
c. Intellectual property assignment: All IP enhancements, code, inventions must belong to the company (or be assigned)
d. Decision-making, voting thresholds, and tie-breaker mechanisms
e. Dispute resolution: mediation, arbitration, escalation paths
f. Exit and removal mechanics: voluntarily exit, forced removal for cause, retirement, incapacity
g. Buyback/redemption rights and how valuation is determined
h. Non-competition, non-solicitation, confidentiality, and restrictive covenants post-exit (with care for enforceability)
i. Obligations on further assistance (“further assurances” clause) — i.e., even after exit, the founder must help transition, sign documents, etc.
2.2. Shareholders’ Agreement / Articles / Corporate Constitution
Often, some of the same terms are embedded in (or cross-referenced by) the shareholders’ agreement or deed of incorporation, so that equity, rights, and remedies are enforceable at the corporate level. This avoids the risk that founders’ private understandings become void because of conflicting corporate bylaws.
2.3. Vesting & Clawback Mechanisms
Vesting ensures that founders don’t walk away with full equity before earning it. A typical structure is 4 years vesting with a 1-year cliff. If a founder leaves early, unvested shares are forfeited. You can further have clawback rights—e.g. if a founder is forced out for misconduct, even vested shares can be repurchased at a formula price.
This aligns incentives and ensures fairness to the company and remaining founders.
2.4. Deadlock Resolution / Tie-Breaker Mechanisms
Because founders often hold similar voting power, disagreements can lead to deadlocks. Some structures to avoid this include:
a. Casting a vote (e.g., chairman or lead founder)
b. Escalation to a third-party advisor or board member
c. Put/Call options: one founder can force the other to buy/sell in a deadlock.
d. Shotgun buy-sell clause: either founder can offer to buy the other at a price; the other must accept or buy at the same price
2.5. Formal Dispute Resolution Clauses
Include in the agreement that, before resorting to court proceedings, the parties must first undergo:
a. Mediation (non-binding)
b. Arbitration (binding)
c. Litigation (as last resort)
3. Exit Clauses: Types, Mechanics & Key Considerations
An “exit clause” is the provision within an agreement that governs how a founder may (or must) leave, and what happens to their shares, obligations, and rights thereafter. Below are key facets to design carefully.
3.1. Exit Triggers vs Voluntary Exit
An exit trigger may include:
a. Voluntary resignation
b. Retirement or permanent incapacity
c. Termination for “cause” (misconduct, breach, non-performance)
d. Termination without cause (say, underperformance)
e. Competing business or breach of non-compete/clause
f. Death or disability
It is critical to define “cause” precisely — what acts constitute cause (fraud, gross negligence, breach of fiduciary duty, moral turpitude, etc.), who determines such cause (board, independent panel), and how the process of determination happens (notice, hearing, evidence).
Some exits are voluntary — a founder might want to leave for personal or strategic reasons — and must notify the company under agreed terms (notice period, handover, etc.).
3.2. Buyback / Redemption / Put/Call Options
Once the exit is triggered (voluntary or otherwise), the agreement should set out:
a. Who can buy: remaining founders, the company, or an external party?
b. When the buyback must be exercised
c. Valuation method: fixed formula, independent valuation, fair market value, discount for lack of liquidity
d. Payment terms: lump sum, installments, escrow, deferred payment
e. Treatment of unvested vs vested shares: unvested are forfeited; vested are repurchased at the agreed price
f. Priority in payments: e.g., in liquidation or sale, pay the buyback first
This clarity avoids later fights over “What is the value of your shares?” or “When do I pay?”
3.3. Notice Periods, Transition Timelines & Handover
To ensure continuity, the exit clause should specify:
a. Minimum notice period for voluntary exit
b. Transition timeline and handover duties
c. Who assumes responsibilities during the transition
d. Access to documentation, training of replacements, etc.
Without this, departing founders may leave abruptly, causing chaos.
3.4. Non-Compete, Non-Solicitation, Confidentiality
To protect the company, the clause should enforce:
a. Non-compete: the exiting founder cannot start or help a competing business for a certain period and within a defined geography
b. Non-solicitation: cannot poach employees, clients, or vendors for a specified period
c. Confidentiality/trade secrets: continuing obligation not to misappropriate the company’s IP or secrets
Be careful: these restrictions must be reasonable (in scope, duration, geography) to be enforceable under many jurisdictions. Overly broad restrictions get struck down.
3.5. Release of Claims, Representations & Warranties, Indemnities
When a founder exits, you typically want a legally binding release — the departing founder gives up future claims (e.g., claims for further shares, consulting fees, defaults). The agreement should:
a. Precisely describe the equity held (number of shares)
b. Exclude rights to future equity, warrants, etc.
c. Cover known and unknown claims (to the extent law permits)
d. Provide indemnity clauses (if the founder caused damage or breach)
e. Be careful when drafting — poorly executed releases or ambiguous terms may be challenged.
Additionally, the releasing clause should comply with local law (some jurisdictions limit the extent of claims that can be waived).
3.6. “Further Assurances” and Cooperation
Even after exit, the departing founder may need to assist with assignments, signatures, regulatory filings, IP transfer, non-compete enforcement, etc. The clause should require them to cooperate for a reasonable period.
3.7. Emergency or Forced Exit Scenarios
A separate clause should cover sudden, triggered exits (e.g. criminal misconduct, bankruptcy, disability). The transition plan must account for immediate actions, like revoking system access, interim management, etc.
4. What to Do When a Dispute Arises
Even with the best planning, disputes may still flare. Here’s how to respond:
4.1. Engage Counsel Early
As soon as tensions are serious, get a corporate lawyer involved. Counsel can:
a. Assess whether there’s an enforceable contract
b. Evaluate litigation risk
c. Suggest strategic pathways (mediate, litigate, negotiate)
d. Advise on interim protective measures (evidence preservation, access control)
4.2. Try to Engage in Mediation / Negotiation
Because litigation is costly and public, resolving disagreements through mediation or direct negotiation in good faith is often advisable. Use whatever dispute-resolution clause exists in your agreement.
4.3. Secure Evidence & Prevent Spoliation
If litigation looks possible:
a. Preserve emails, documents, chat logs, and version histories
b. Lock or revoke access to proprietary systems (code, servers, internal tools)
c. Retrieve company assets (laptops, phones)
d. Audit IP ownership
These steps mitigate risks like claims of data theft or disputes over who owns what.
4.4. Evaluate Claims & Counterclaims
Disputing founders often assert multiple legal claims: breach of contract, fraud, misrepresentation, equity claims, IP theft, defamation, etc. The defending party must assess exposure and strategy.
4.5. Consider Interim Relief
If a founder threatens to misuse access, misappropriate intellectual property, or harm the business, it may be necessary to seek temporary injunctions or restraining orders, depending on the jurisdiction and the severity of the threat.
4.6. Settlement Strategy & Risk Assessment
Often, the best path is to negotiate a settlement: better cost control, quicker resolution, preserving relationships, and reducing risk. But always check that the settlement terms:
a. Cleanly resolve all claims
b. Confirm the equity/ownership position
c. Handle post-exit obligations
d. Ensure enforceability
5. Legal & Practical Steps for Executing a Founder Exit
When the decision is made (or forced) to exit a founder, here’s a step-by-step legal checklist.
5.1. Trigger the Exit Under the Agreement
Follow the precise procedure set out in the agreement (notice period, board decision, cause determination, etc.). Don’t skip steps—those procedural missteps can be a basis for challenge.
5.2. Valuation & Buyback
Invoke the buyback clause, obtain valuation (per formula or by independent appraiser), and settle payment terms (lump sum or installment). If the departing founder refuses to sell, you may need to enforce your rights in arbitration or court.
5.3. Execute a Release & Settlement Agreement
Prepare a detailed exit agreement/separation agreement that:
a. Confirms how many shares the founder continues to hold (if any)
b. Confirms that unvested shares are forfeited
c. Contains the release of claims (current and future)
d. Sets out any indemnity obligations
e. Details post-exit obligations (non-compete, confidentiality, further assistance)
f. Addresses how the founder will present their departure publicly
g. Retains confidentiality over terms (if needed)
5.4. Intellectual Property Assignment & Transfer
Make sure all IP (code, designs, inventions) is assigned to the company robustly. If any IP was omitted earlier, rectify it now. Include “further assurances” so the founder must help in the future.
5.5. Access, Systems, and Data
a. Revoke access to internal systems, repos, servers, and cloud accounts
b. Collect devices, credentials
c. Secure backups and audit access logs
d. Ensure no unauthorized data removal
5.6. Handover & Transition
Ensure knowledge transfer:
a. Conduct training sessions
b. Share documentation, licenses, codes, and vendor contacts
c. Reassign responsibilities
d. Announce the change internally/externally in a controlled, agreed way
5.7. Communication & PR Strategy
When a founder leaves, there will be questions. The exit agreement should control what is said publicly, in press releases, and to internal teams. Avoid statements that open defamation or damaging claims.
5.8. Internal Corporate Actions
a. Update the cap table, share registers
b. Update board or director positions
c. Possibly amend the constitutional documents or shareholder agreements
d. Notify regulators (if required in your jurisdiction)
5.9. Post-Exit Monitoring & Enforcement
Monitor compliance with non-compete, confidentiality, and indemnities. Be ready to enforce if violations occur.
6. Pitfalls, Challenges & Best Practices
Here are frequent traps and recommended practices to avoid them:
6.1. Vagueness and Ambiguity
Exit and release clauses that are vague invite litigation. For example, “for fair value” without a definition is dangerous. Use precise formulas or agreed valuation methods.
6.2. Overbroad Restrictive Covenants
Courts often refuse to enforce non-compete or non-solicitation clauses if they are overbroad in time, geography, or scope. Ensure these constraints are reasonable in your jurisdiction.
6.3. No Dispute Resolution Clause
If you have no mediation/arbitration clause, you may be forced into costly public litigation. Always incorporate ADR clauses.
6.4. Failure to Update the Agreement Over Time
As the company evolves, the exit or dispute clauses may become obsolete. Periodically review and amend.
6.5. Bad Leaver vs Good Leaver Definitions
Many agreements distinguish “good leaver” (leaves amicably or under agreed conditions) from “bad leaver” (misconduct). The difference affects price, rights, and exit treatment. Be very clear about which actions make one a “bad leaver.”
6.6. Inadequate Release / Incomplete Clause
Sometimes, release agreements omit unknown claims or lack breadth, leaving room for ex-founders to sue later. That’s a common error.
6.7. Underestimating Emotional Complexity
Founders often have personal relationships. Be careful in communication, negotiation style, and respect. Escalation to legal conflict should be the last resort.
7. Illustrative Example
A recent high-profile Indian founders dispute that highlighted the absence of a founders’ agreement is the Housing.com case:
a. com, founded in 2012 by 12 IIT Bombay alumni, raised significant venture capital funding by 2015
b. A serious dispute arose mainly between co-founder and CEO Rahul Yadav, other co-founders, and the board over control and decision-making authority.
c. The conflict escalated into a power struggle, resulting in internal friction, several founder resignations, and eventually in Rahul Yadav being ousted by the board.
d. One reason the dispute worsened was the absence of a clear founders’ agreement that delineated roles, responsibilities, decision-making processes, and dispute-resolution mechanisms.
e. The case highlighted how a lack of such an agreement can cause misalignment among founders, damage the company’s reputation, and derail growth.
f. Following the dispute, many startups and experts emphasized the importance of a strong founders’ agreement, including clauses on roles, equity, IP, exit, and dispute-resolution mechanisms in India.
g. This dispute is widely cited as an example of why Indian startups must adopt clear Founders’ agreements early to avoid destructive conflicts.
8. Conclusion
Handling founder disputes and exit clauses legally is one of the most delicate, high-stakes tasks in a startup’s lifecycle. Done poorly, disputes can bleed resources, destroy morale, and even collapse the business. When executed effectively, the clarity and protective exit mechanisms incorporated into the agreement facilitate smoother transitions and preserve value.
a. Do not delay — establish a founders’ agreement and exit clauses before tensions arise.
b. Be precise when drafting — clearly define roles, valuation methods, triggers, and procedures.
c. Use vesting, clawbacks, non-compete, and release provisions carefully and reasonably.
d. Insist on robust dispute resolution mechanisms.
e. When conflict arises, act early, preserve evidence, and negotiate where possible.
f. On exit, follow the contract to the letter: valuation, release, IP assignment, access, and handover.
g. Keep your agreements current as the company evolves.
h. Always work with qualified legal counsel familiar with your jurisdiction’s corporate and contract law.
For any clarifications or queries, please feel free to reach out to us at admin@fintracadvisors.com
Disclaimer
The content published on this blog is for informational purposes only. The opinions expressed here are solely those of the respective authors and do not necessarily reflect the views of Fintrac Advisors. No warranties are made regarding this information’s completeness, reliability, or accuracy. Any actions taken based on the information presented in this blog are solely at the reader’s risk, and we will not be liable for any losses or damages resulting from its use. It is recommended that professional expertise be sought for such matters. External links on this blog may direct users to third-party sites beyond our control. We do not take responsibility for their nature, content, or availability.
