'You're Fired!'

According to Fred Wilson, a venture capitalist and investor in e-commerce start-up companies: “Transitions are never easy on the people involved and the company that goes through them. ' But they are inevitable in any company's evolution.” See, “Why Founders Get Fired,” Inc.com, http://bit.ly/u4cHUC.

The Harvard Business School study on founder succession discussed in our December issue (“Founder-CEO Succession and the Paradox of Entrepreneurial Success,” by Noah Wasserman (Organization Science, Vol. 14, No. 2, p. 151, March-April 2003, http://bit.ly/qdqSVD)), provided the statistics cited in the recent Inc. magazine story cited above showing the prevalence of such terminations. According to Wasserman: “The percentage of founders that stay on with the company for extended periods of time as the CEO are very low, especially in high-potential ventures.”

Transitions Can Be No Fun

Of course, as in the reality shows, transitions aren't any fun for the victim, either. Steve Jobs described his 1985 firing from Apple as “awful-tasting medicine” ' although from the perspective of business success 20 years later, said: “I guess the patient needed it. I didn't see it then, but it turned out that getting fired from Apple was the best thing that could have ever happened to me.” (http://en.wikipedia.org/wiki/Steve_Jobs.)

Somewhat more bitterly, Noah Glass, an ousted cofounder of Twitter, was not so charitable to those who fired him. “I did feel betrayed,” Glass said. “I felt betrayed by my friends, by my company, by these people around me I trusted and that I had worked hard to create something with.” See, “Twitter's Lost Co-Founder Noah Glass on Being Fired, Being Forgotten and Being Betrayed,” AllTwiitter, http://bit.ly/vynmpm.

(But getting fired in such situations doesn't always leave the founder penniless on the street; indeed, better or more experienced managers may multiply the value of the founder's equity many times over, in ways he never could have done for himself. Even a fired founder will likely remain a major shareholder, with a significant voice in the company's future (albeit not in the board room or executive suite, choosing that future)).

Smooth Planning Not Always Possible

Last month, I discussed why all firms, and especially technology firms, need to plan for a change in leadership. But a smooth transition is not always possible. Sometimes, the change must be abrupt, even if it means separating from the founder of a company.

Yet surprisingly, such firings aren't rare ' the topic is discussed regularly in the business press. One business publication even created a slideshow of ousted founders, because such changes occur so frequently (see, “Who's the Boss?” at Inc.com, http://bit.ly/v0FJc6).

One entrepreneur and investor, Chris Yeh, has even published advice on “How to Avoid Getting Fired from Your Own Company” (http://tcrn.ch/rIAzzb). As I wrote this article, The New York Times' technology columnist, David Pogue, labeled 2011 “The Year of C.E.O. Failures” (http://nyti.ms/rRw0dd).

So Many Firings Today

So why are such firings so common in tech firms? Although each has its own story, many causes appear again and again. For example, the entrepreneurial whiz kid who started the firm had a skill set that just didn't meet the growing company's needs. Or, a great engineer or designer doesn't automatically make someone a success in business; for example, Google's founders famously brought in Eric Schmidt to provide the business management skills they knew they did not have.

Missteps can also occur when the founder simply doesn't understand the demands on the leader of a bureaucratized firm run by the independent board demanded by outside investors. The modern CEO must answer to many constituencies, not just the sales and marketing departments, or the product-development people, which may not be the way the entrepreneur learned to build the company.

The entrepreneur must also learn to work under the direction of others, particularly the direction of a full board of directors who may have different priorities than he or she had.

Again using the firing of Steve Jobs as an example, Apple's then CEO, John Sculley, said (with the 20/20 hindsight of Apple's subsequent success after Jobs' return): “My sense is that it probably would never have broken down between Steve and me if we had figured out different roles. Maybe he should have been the CEO and I should have been the president. It should have been worked out ahead of time, and that's one of those things you look to a really good board to do.” See, “Regrets from the Man Who Fired Steve Jobs,” The Daily Beast, http://bit.ly/u2GvUn.

This conflict can be particularly intense if the founder wants to continue to grow and develop the company, but his investors ' especially aggressive fund managers with a time horizon no longer than their next bonus pool target ' prefer to work toward a sale of the company, to cash out their investment funds.

In addition, the stereotypical inventor who spent years working in a lab to develop something marketable may never have had time or opportunity to develop industry contacts needed to grow a business in today's collaborative world. Nor will he or she be likely to have had experience with bankers, finance experts or even the media ' all critical skills for a tech-firm leader today.

According to Robert Adelson, an attorney quoted in the Inc. article cited earlier: “Typically founders are men and women who are of great passion, but that doesn't translate into scaling a company and building a large organization. The person who took that company from nothing to $5 million has done a daunting job, but that person, in the view of the VC, is very often not the person that will take them from $5 million to $100 million.”

Disparate Visions

Another common source of founder separation occurs when the founder's vision no longer matches that of the board, hired by investors to represent all shareholders, not just the founder and insiders. The board may be less willing to take risks to grow the company rapidly, or may prefer a different focus in product selection and development than what the founder envisions for what once was “his” or “her” company. The board, after all, owes fiduciary duties to all equity owners, and must balance those duties (and their personal legal exposure to shareholder suits) if they do not properly exercise that judgment.

One fired founder, Jeffrey Hollender of Seventh Generation, admitted his own “shortcomings,” particularly his company's failure to make money for 13 years “because he was perpetually torn between doing the right thing and the company's bottom line.” As a result, “his day-to-day focus on cleaning up the cleaning products industry was getting pushed to the sidelines” by his focus on social activism. See, “Inside Seventh Generation's Firing of Founder Jeffrey Hollender,” Fast Company, http://bit.ly/stdEUb.

Hard Assets, Hard Decisions

Other disputes may be less philosophical. Some founders prefer to keep ownership of critical assets ' such as a patent, or key piece of real estate ' in their own name, outside the company. On one level, this technique may be a simple way of protecting the founder's income stream in royalties or rent from the company. More realistically, however, such a founder usually is trying to preserve the appearance, if not the reality, of maintaining leverage and control, even if he or she has sold out to investors.

In fact, though, when conflicts arise, the founder will almost certainly have to accede to the board's wishes and transfer the asset to the company. The founder is typically an executive and a large shareholder, and, as such, owes the same (if not greater) fiduciary duties to investors as board members owe to all investors.

In other words, the founder himself cannot charge whatever licensing fee or rent he feels like when allowing his own property to be used by the company, but must be governed by his legal obligations to investors and to the company stated in the company's formation documents and basic corporate law ' unless he had the foresight to include, in the company's formation documents, the fiduciary duty waiver now permitted under some states' laws.

(Such laws permit waivers of the fundamental duties of loyalty and care that have governed business-law relationships since the dawn of the investor-owned corporate relationship; not all states allow such waivers, although Delaware does. See, Del. Limited Liability Company Act Section 18-1101; Del. Code. Chapter 6, Section 18-1101, http://1.usa.gov/tEkqHZ.)

Easy Departures, Soft Landings

At a baser level, some founder disputes and exits simply are the result of greed ' on both sides of the table. In Foster v. Churchill, 215 A.D.2d 155, 626 N.Y.S.2d 115 (NY App. Div. 1995), the court found a very basic reason for the founder's termination. “[T]he ' defendants instigated the plaintiffs' discharge because Microband was effectively bankrupt and wanted to save money by withholding the contractually mandated severance payments, rather than out of any dissatisfaction with plaintiffs' competency as managers of the company.”

Because it seems clear that no well-advised founder should expect to remain in his position, his lawyer's initial advice when forming the company should include relatively standard types of protection ' if termination is inevitable, at least the founder's landing should be comfortable.

Counsel representing the founder should focus on vesting and acceleration of options, severance benefits and (if desired) preserving the right to return to work, through a carefully crafted non-competition agreement that does not bar him from doing what he prefers in business (or at least not for too long).

Agreements concerning voting or sale of the stock, such as a tag-along right, build contractual and fiduciary protections (the fiduciary duty of a majority holder to the minority owners) against total removal. (Of course, the company's attorney will insist on a drag-along right; if the founder remains a significant shareholder, he shouldn't be able to delay or block a major deal favored by investors.)

Tech Founder Cautions

A founder with technical expertise should be even more careful about signing standard confidentiality and invention-assignment agreements, because all of his future research and product development work may be committed to his company, whether or not he remains an employee or owner to enjoy the benefits of his own creative work. With rapid product and technology cycles, a tech founder may be able to find a new position reasonably quickly ' if his non-competition agreement doesn't keep him on the sidelines.

From the employer perspective, remember: That new position could be with a competitor. While courts sometimes disfavor enforcing restrictions on future employment against an employee terminated involuntarily, at the executive level the compensation package and perks weigh in favor of upholding a reasonable restriction on future employment.

In negotiating protection for the founder, all parties should be attentive to legal/ethical issues concerning representation. While many start-up firms retain one attorney to represent all parties ' the company and all investors ' to control costs as the company prospers, that situation must change. The “company attorney” cannot always adequately represent the founder, especially when negotiating benefits or compensation packages where she has conflicting loyalties to the company and to her long-time client. Disclosures to a person with whom the founder has worked closely for many years could whipsaw the founder, if that attorney has a legal duty to use that information to help the company (even if at the expense of her old friend and client).

Plan an Announcement

Boards contemplating terminating a founder should consider, early in the planning, how to make the public announcement, an ancillary but critical point. A terse report of the departure of a key executive cannot help maintain the value of the equity; it massages the reasons for the termination.

Because the departing founder will often keep a significant equity position, the company and the former executive will have a mutual economic interest in presenting the termination in the most favorable light to prevent a price drop. It is in no one's interest to cause a run on the company's stock by investors selling out of fear of a leadership void.

Instead, a positive announcement of an executive's desire to “explore other opportunities” can help preserve the stock value ' but such relief is far easier to create in advance, without pressure, than in the crucible of the days before and after the sacking of the founder, which the board may have had to do in self-defense of the company.

A future observer of the reality shows that seem to be the only thing on television today might think that people of the 21st century lived to fire people.

From Donald Trump's iconic, “You're fired!” in The Apprentice, to an awkward, “You won't be coming back” in the ubiquitous cooking or talent competitions, our voyeuristic society seems to enjoy seeing people who fail to make the grade be humiliated ' even if making the grade (or not) has no significance to anyone other than the humiliated contestant.

But people forced to do the same task in business find no such joy in having to dismiss a business leader, especially when the person being dismissed is the founder of the company ' the visionary who built it from scratch.

According to Fred Wilson, a venture capitalist and investor in e-commerce start-up companies: “Transitions are never easy on the people involved and the company that goes through them. ' But they are inevitable in any company's evolution.” See, “Why Founders Get Fired,” Inc.com, http://bit.ly/u4cHUC.

The Harvard Business School study on founder succession discussed in our December issue (“Founder-CEO Succession and the Paradox of Entrepreneurial Success,” by Noah Wasserman (Organization Science, Vol. 14, No. 2, p. 151, March-April 2003, http://bit.ly/qdqSVD)), provided the statistics cited in the recent Inc. magazine story cited above showing the prevalence of such terminations. According to Wasserman: “The percentage of founders that stay on with the company for extended periods of time as the CEO are very low, especially in high-potential ventures.”

Transitions Can Be No Fun

Of course, as in the reality shows, transitions aren't any fun for the victim, either. Steve Jobs described his 1985 firing from Apple as “awful-tasting medicine” ' although from the perspective of business success 20 years later, said: “I guess the patient needed it. I didn't see it then, but it turned out that getting fired from Apple was the best thing that could have ever happened to me.” (http://en.wikipedia.org/wiki/Steve_Jobs.)

Somewhat more bitterly, Noah Glass, an ousted cofounder of Twitter, was not so charitable to those who fired him. “I did feel betrayed,” Glass said. “I felt betrayed by my friends, by my company, by these people around me I trusted and that I had worked hard to create something with.” See, “Twitter's Lost Co-Founder Noah Glass on Being Fired, Being Forgotten and Being Betrayed,” AllTwiitter, http://bit.ly/vynmpm.

(But getting fired in such situations doesn't always leave the founder penniless on the street; indeed, better or more experienced managers may multiply the value of the founder's equity many times over, in ways he never could have done for himself. Even a fired founder will likely remain a major shareholder, with a significant voice in the company's future (albeit not in the board room or executive suite, choosing that future)).

Smooth Planning Not Always Possible

Last month, I discussed why all firms, and especially technology firms, need to plan for a change in leadership. But a smooth transition is not always possible. Sometimes, the change must be abrupt, even if it means separating from the founder of a company.

Yet surprisingly, such firings aren't rare ' the topic is discussed regularly in the business press. One business publication even created a slideshow of ousted founders, because such changes occur so frequently (see, “Who's the Boss?” at Inc.com, http://bit.ly/v0FJc6).

One entrepreneur and investor, Chris Yeh, has even published advice on “How to Avoid Getting Fired from Your Own Company” (http://tcrn.ch/rIAzzb). As I wrote this article, The New York Times' technology columnist, David Pogue, labeled 2011 “The Year of C.E.O. Failures” (http://nyti.ms/rRw0dd).

So Many Firings Today

So why are such firings so common in tech firms? Although each has its own story, many causes appear again and again. For example, the entrepreneurial whiz kid who started the firm had a skill set that just didn't meet the growing company's needs. Or, a great engineer or designer doesn't automatically make someone a success in business; for example, Google's founders famously brought in Eric Schmidt to provide the business management skills they knew they did not have.

Missteps can also occur when the founder simply doesn't understand the demands on the leader of a bureaucratized firm run by the independent board demanded by outside investors. The modern CEO must answer to many constituencies, not just the sales and marketing departments, or the product-development people, which may not be the way the entrepreneur learned to build the company.

The entrepreneur must also learn to work under the direction of others, particularly the direction of a full board of directors who may have different priorities than he or she had.

Again using the firing of Steve Jobs as an example, Apple's then CEO, John Sculley, said (with the 20/20 hindsight of Apple's subsequent success after Jobs' return): “My sense is that it probably would never have broken down between Steve and me if we had figured out different roles. Maybe he should have been the CEO and I should have been the president. It should have been worked out ahead of time, and that's one of those things you look to a really good board to do.” See, “Regrets from the Man Who Fired Steve Jobs,” The Daily Beast, http://bit.ly/u2GvUn.

This conflict can be particularly intense if the founder wants to continue to grow and develop the company, but his investors ' especially aggressive fund managers with a time horizon no longer than their next bonus pool target ' prefer to work toward a sale of the company, to cash out their investment funds.

In addition, the stereotypical inventor who spent years working in a lab to develop something marketable may never have had time or opportunity to develop industry contacts needed to grow a business in today's collaborative world. Nor will he or she be likely to have had experience with bankers, finance experts or even the media ' all critical skills for a tech-firm leader today.

According to Robert Adelson, an attorney quoted in the Inc. article cited earlier: “Typically founders are men and women who are of great passion, but that doesn't translate into scaling a company and building a large organization. The person who took that company from nothing to $5 million has done a daunting job, but that person, in the view of the VC, is very often not the person that will take them from $5 million to $100 million.”

Disparate Visions

Another common source of founder separation occurs when the founder's vision no longer matches that of the board, hired by investors to represent all shareholders, not just the founder and insiders. The board may be less willing to take risks to grow the company rapidly, or may prefer a different focus in product selection and development than what the founder envisions for what once was “his” or “her” company. The board, after all, owes fiduciary duties to all equity owners, and must balance those duties (and their personal legal exposure to shareholder suits) if they do not properly exercise that judgment.

One fired founder, Jeffrey Hollender of Seventh Generation, admitted his own “shortcomings,” particularly his company's failure to make money for 13 years “because he was perpetually torn between doing the right thing and the company's bottom line.” As a result, “his day-to-day focus on cleaning up the cleaning products industry was getting pushed to the sidelines” by his focus on social activism. See, “Inside Seventh Generation's Firing of Founder Jeffrey Hollender,” Fast Company, http://bit.ly/stdEUb.

Hard Assets, Hard Decisions

Other disputes may be less philosophical. Some founders prefer to keep ownership of critical assets ' such as a patent, or key piece of real estate ' in their own name, outside the company. On one level, this technique may be a simple way of protecting the founder's income stream in royalties or rent from the company. More realistically, however, such a founder usually is trying to preserve the appearance, if not the reality, of maintaining leverage and control, even if he or she has sold out to investors.

In fact, though, when conflicts arise, the founder will almost certainly have to accede to the board's wishes and transfer the asset to the company. The founder is typically an executive and a large shareholder, and, as such, owes the same (if not greater) fiduciary duties to investors as board members owe to all investors.

In other words, the founder himself cannot charge whatever licensing fee or rent he feels like when allowing his own property to be used by the company, but must be governed by his legal obligations to investors and to the company stated in the company's formation documents and basic corporate law ' unless he had the foresight to include, in the company's formation documents, the fiduciary duty waiver now permitted under some states' laws.

(Such laws permit waivers of the fundamental duties of loyalty and care that have governed business-law relationships since the dawn of the investor-owned corporate relationship; not all states allow such waivers, although Delaware does. See, Del. Limited Liability Company Act Section 18-1101; Del. Code. Chapter 6, Section 18-1101, http://1.usa.gov/tEkqHZ.)

Easy Departures, Soft Landings

At a baser level, some founder disputes and exits simply are the result of greed ' on both sides of the table. In Foster v. Churchill , 215 A.D.2d 155, 626 N.Y.S.2d 115 (NY App. Div. 1995), the court found a very basic reason for the founder's termination. “[T]he ' defendants instigated the plaintiffs' discharge because Microband was effectively bankrupt and wanted to save money by withholding the contractually mandated severance payments, rather than out of any dissatisfaction with plaintiffs' competency as managers of the company.”

Because it seems clear that no well-advised founder should expect to remain in his position, his lawyer's initial advice when forming the company should include relatively standard types of protection ' if termination is inevitable, at least the founder's landing should be comfortable.

Counsel representing the founder should focus on vesting and acceleration of options, severance benefits and (if desired) preserving the right to return to work, through a carefully crafted non-competition agreement that does not bar him from doing what he prefers in business (or at least not for too long).

Agreements concerning voting or sale of the stock, such as a tag-along right, build contractual and fiduciary protections (the fiduciary duty of a majority holder to the minority owners) against total removal. (Of course, the company's attorney will insist on a drag-along right; if the founder remains a significant shareholder, he shouldn't be able to delay or block a major deal favored by investors.)

Tech Founder Cautions

A founder with technical expertise should be even more careful about signing standard confidentiality and invention-assignment agreements, because all of his future research and product development work may be committed to his company, whether or not he remains an employee or owner to enjoy the benefits of his own creative work. With rapid product and technology cycles, a tech founder may be able to find a new position reasonably quickly ' if his non-competition agreement doesn't keep him on the sidelines.

From the employer perspective, remember: That new position could be with a competitor. While courts sometimes disfavor enforcing restrictions on future employment against an employee terminated involuntarily, at the executive level the compensation package and perks weigh in favor of upholding a reasonable restriction on future employment.

In negotiating protection for the founder, all parties should be attentive to legal/ethical issues concerning representation. While many start-up firms retain one attorney to represent all parties ' the company and all investors ' to control costs as the company prospers, that situation must change. The “company attorney” cannot always adequately represent the founder, especially when negotiating benefits or compensation packages where she has conflicting loyalties to the company and to her long-time client. Disclosures to a person with whom the founder has worked closely for many years could whipsaw the founder, if that attorney has a legal duty to use that information to help the company (even if at the expense of her old friend and client).

Plan an Announcement

Boards contemplating terminating a founder should consider, early in the planning, how to make the public announcement, an ancillary but critical point. A terse report of the departure of a key executive cannot help maintain the value of the equity; it massages the reasons for the termination.

Because the departing founder will often keep a significant equity position, the company and the former executive will have a mutual economic interest in presenting the termination in the most favorable light to prevent a price drop. It is in no one's interest to cause a run on the company's stock by investors selling out of fear of a leadership void.

Instead, a positive announcement of an executive's desire to “explore other opportunities” can help preserve the stock value ' but such relief is far easier to create in advance, without pressure, than in the crucible of the days before and after the sacking of the founder, which the board may have had to do in self-defense of the company.