Co-Founder and Startup Disputes in the Bay Area

Startups break up the way partnerships do, only faster and with more at stake on paper. A co-founder is removed from the board, fired as an officer, and told his unvested shares are being repurchased. Two founders disagree about a financing, a pivot or a sale, and neither will budge. A departing founder starts a competing company, and the company claims its code and customer list went with him. Reiser Law, P.C. represents founders, early employees, investors and companies in these disputes from our Walnut Creek office, in California state and federal courts and in arbitration.

Start with the documents and the state of incorporation

Most startup disputes are decided by a handful of documents: the certificate or articles of incorporation, the bylaws, the founders' stock purchase or restricted stock agreements, any voting or investor rights agreements, the founder's offer letter or employment agreement, and the invention assignment agreement. These documents set vesting schedules, repurchase rights, board composition, voting obligations and, often, arbitration and forum clauses.

Many Bay Area startups are incorporated in Delaware, even when they operate here. Delaware law then governs many questions about the company's internal affairs, such as directors' duties, and a forum clause may require some claims to be filed in Delaware. California law still applies to many other issues, including employment, noncompetition and certain inspection rights. Identifying which state's law governs each claim is the first step.

Removal from the board and from management

For a California corporation, any or all directors may be removed without cause if the removal is approved by the outstanding shares, but a director cannot be removed, unless the entire board is removed, when the votes cast against removal would be enough to elect the director under cumulative voting. Cal. Corp. Code § 303(a)(1). Directors elected by a class of shares may be removed only by that class. § 303(a)(2).

Officers are chosen by the board and, unless the articles or bylaws provide otherwise, serve at the pleasure of the board, subject to any rights the officer has under an employment contract. Cal. Corp. Code § 312(b). That means a founder can usually be removed as chief executive, but the removal may trigger severance, acceleration or other rights under the founder's agreements. Voting agreements among founders and investors frequently control who sits on the board, so the removal may also be challenged as a breach of those agreements.

Equity, vesting and repurchase rights

Founders' shares are usually subject to vesting, with the company holding a right to repurchase unvested shares when the founder leaves. Disputes center on whether the founder was terminated for cause, whether vesting accelerated on a change of control or termination, whether the repurchase notice was timely and properly priced, and whether a later amendment to the founder's agreement was valid. Many of these turn on contract language, and on whether the company exercised its discretion under the agreement in good faith. Every California contract carries an implied covenant of good faith and fair dealing, though it cannot override the agreement's express terms; see our article on the implied covenant in California.

Fiduciary duties and self-dealing

Directors and controlling stockholders owe duties to the company and its stockholders. In a California corporation, majority shareholders must use their control "in a fair, just, and equitable manner." Jones v. H.F. Ahmanson & Co., 1 Cal. 3d 93, 108 (1969). Founder disputes often involve allegations that insiders approved a dilutive financing, a related-party deal or a sale on terms that favored themselves. Some of these claims belong to the company and must be brought derivatively. Our page on partnership, LLC and shareholder disputes explains derivative claims and their procedural requirements.

Information rights

A founder who still holds stock can usually demand information. California's inspection statute lets a shareholder inspect the accounting books, records and minutes on written demand, for a purpose reasonably related to the holder's interests as a shareholder, and it applies to domestic corporations and to foreign corporations that keep records in California or have their principal office here. Cal. Corp. Code § 1601(a). The right cannot be limited by the articles or bylaws. § 1601(b). Investor rights agreements may provide additional, contractual information rights.

Competing companies, code and customers

Noncompetes. In California, every contract by which anyone is restrained from engaging in a lawful profession, trade or business is to that extent void. Cal. Bus. & Prof. Code § 16600(a). A void noncompete is unenforceable regardless of where and when it was signed, and an employee, former employee or prospective employee who prevails in an action to enforce these protections is entitled to reasonable attorney's fees and costs. Cal. Bus. & Prof. Code § 16600.5(a), (e).

Trade secrets. The ban on noncompetes does not permit taking trade secrets. A trade secret is information, such as a formula, program, method, technique, process or compilation, that derives independent economic value from not being generally known, and that is the subject of reasonable efforts to maintain its secrecy. Cal. Civ. Code § 3426.1(d). Customer lists, source code and pricing models may or may not qualify, depending on how they were protected.

Inventions. Founders and employees typically assign inventions to the company. California limits those assignments: they do not apply to an invention the employee developed entirely on his or her own time without using the employer's equipment, supplies, facilities or trade secret information, unless the invention relates to the employer's business or actual or demonstrably anticipated research or development, or results from work the employee performed for the employer. Cal. Lab. Code § 2870(a).

How we handle founder disputes

1. Map the documents. We assemble every agreement the founder signed and every board and stockholder consent affecting the founder's role and equity.
2. Determine governing law and forum. We identify where each claim must be brought and which state's law applies.
3. Protect your position early. Inspection demands, preservation letters and, where necessary, requests for interim relief keep options open.
4. Negotiate a separation. Many founder disputes end in a negotiated exit: a share repurchase, a release, a revised vesting schedule or a secondary sale.
5. Litigate or arbitrate if necessary. When negotiation fails, we pursue the claims in the forum the documents require.

What to gather before you call

• Certificate or articles of incorporation and bylaws
• Founders' stock purchase or restricted stock agreements, and any 83(b) election filed
• Voting, investor rights and right-of-first-refusal agreements
• Offer letter, employment agreement and invention assignment agreement
• Board and stockholder consents and minutes
• The capitalization table and recent financing documents
• Communications about your removal or the dispute

Questions clients ask

Can my co-founders remove me as CEO?

Usually, yes. Officers generally serve at the pleasure of the board. Removal may still trigger contractual rights, such as severance or vesting acceleration, and may be challenged if it breached a voting agreement or was part of a scheme to take your equity.

Can the company buy back my shares when I leave?

If your shares are unvested and your agreement gives the company a repurchase right, generally yes, on the terms the agreement sets. Vested shares are usually yours, subject to any transfer restrictions and rights of first refusal.

Can I start a competing company?

In California, noncompete agreements are generally void. You still may not use the company's trade secrets, and inventions you created for the company may belong to it.

Our company is incorporated in Delaware. Does California law apply?

Partly. Delaware law usually governs the company's internal affairs, while California law governs many employment and contract issues. A forum clause may also require some claims to be filed in Delaware.

Talk to us

Michael J. Reiser, the firm's founder, has been a member of the State Bar of California since 1988. Sean Svendsen, also a member of the State Bar of California, handles California litigation with the firm from the Bay Area. To discuss a founder or startup dispute, call (925) 256-0400, email michael@reiserlaw.com or sean@reiserlaw.com, or use our contact page. Our office is at 1990 North California Blvd, 8th Floor, Walnut Creek, CA 94596. See also Bay Area business litigation and Bay Area investment fraud.

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