What Do You Gain by Buying Out a Co-founder? Six Points

Situation: A CEO founded his company with a long-term friend. For several years, this co-founder has contributed little and has proven to be difficult with key employees. In an important sense, the co-founder has become a distraction. A challenge is that the co-founder is a significant shareholder. What do you gain by buying out a co-founder?

Advice from the CEOs:

  • First and foremost – peace of mind. While the CEO and his allies control a majority of shares there is no guarantee that this remains the case. Long-term it can cause headaches to have a large block of shares in the hands of someone who could be hostile. The challenge is gaining control of a solid majority of shares at a reasonable price.
  • How is the value of the co-founder’s shares determined?
    • In most minority interest situations, minority interest is discounted because it is of limited value to a non-company purchaser. While it may be necessary to pay a premium to gain controlling interest in the company, this will be a premium over the discounted minority interest value, not over the fair value for all shares.
  • There are two aspects to a purchase: price and terms. It is acceptable to accept the co-founder’s price, but insist on favorable terms, e.g., 10 years to pay at 5% interest.
    • Set the terms so that the company guarantees the payment, not the CEO personally.
  • At this point the co-founder is a disruptive force within the company. Act now before more damage is done.
    • As to order of business, take action with respect to the co-founder first, then negotiate the purchase of his shares after he is no longer an employee.
    • Be sure to communicate the decision effectively to the other employees. Speak to the long-term strategic value of the company, the CEO’s vision for the company, and a determination to build the company into a viable entity with a range of customers and growth opportunities for the team.
  • Important steps as you move forward:
    • Have a plan.
    • Speak to an attorney – the company should pay but this is the CEO’s attorney, not the company’s attorney. Assure that as CEO you limit personal exposure and do things appropriately.
    • Assure that the employees understand and support this action and that they clearly understand the plan going forward.
    • Offer the co-founder a more generous severance package than would ordinarily be considered prudent.
    • Fire the co-founder as soon as plans are in place and announce a Board Meeting 30 days hence to discuss the management restructuring.
  • As a final note, this is one of the most difficult things that must be done by a CEO. The co-founder has been a long-term friend. Nothing about this is easy. It is likely to get more painful before it gets better. In the long run, however, this can be better for both individuals. Work toward that objective.

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