Call Home

Smarter Growth Matters

Vol. 1, No. 1
October, 2015

A Delicate Dilemma:

Extracting a founder from their own company

Early stage and smart growth companies encounter a myriad of challenges in their journey to scaling but one experience most of them don’t hope to encounter is internal stresses that necessitate the extraction of a founder.

Indeed, the statistics are not encouraging. The two most common factors that lead to start-up failures are running out of money and founding team implosions.

When the relationship between founders has degraded, company leaders need to seriously ask themselves if it can be salvaged by fixing the problems that led to the strife. If the situation is terminal, the question becomes who should leave and how to do you extract them from the organization without afflicting more damage beyond what has already been endured?

Should an individual offer to voluntarily resign, or should someone be asked to leave? It depends on the relative leverage each founding team member has, who is most essential to the continued life of the company at that stage, the amount of equity held by each leader and their relationship to (or seat held on) the Board.

Obviously, extracting the right individual becomes all the more difficult when each co-founder has equal status (i.e., equity, IP, Board seat) in the company. Investor status is usually a point of particular complexity in any separation negotiation. Can the financial interests of the departing co-founder be protected with appropriate and fair terms?

Here are a few points to consider if you come into the unfortunate challenge of creating a separation strategy:

  • Promote frank and transparent conversation with all parties involved – and solicit the input of other key stakeholders so that any decision has involved some consensus building.
  • Poll key investors for advice on the whole situation but determine who is most appropriate to contact during the negotiation and who should be informed after a decision has been reached. Involving a strong lead investor from the onset can help influence other investors and pave the path to a much smoother transition.
  • Use the consensus process to exercise a fair separation by addressing what they care about most: Do they need cash to leave, or will retaining an equity position suffice? A determining factor should be how early in vesting are they and is it sensible to allow them to retain the portion of equity they vested so far? If their time has been short, converting to an advisor role with a reduced equity stake might be the most logical. The other alternative is to buy them out.
  • If a founder is pre-cliff, there are no shares to purchase from them so it might be best to pay out a cash severance. However, if they are post-cliff, stock agreement clauses may cover issues of fraud or other actions they took that put the company at risk and therefore subject them to automatically losing their shares.
  • When a founder is also a board member, it is often best to make a clean break but such an unplanned vacancy could create a leadership vacuum that is not always so easy to fill; timeliness is everything during an early-stage acceleration.
  • In all cases, seeking early input from legal counsel is wise as they may help prepare the necessary paperwork covering the different options before you initiate the separation discussion. Preparing for these delicate conversations by outlining the logic for each option will not only enable the leadership team to thoroughly reflect on the best way forward for the company, but also aid legal counsel in constructing the best support mechanisms for executing on whatever direction is mutually determined.

Entering this difficult situation prepared will avoid legal pitfalls and promote swift resolution. It will also provide uniformity of communication to the range of internal and external stakeholders, such as investors, advisors, strategic partners and suppliers, employees, customers and your industry at large – to say nothing of how to handle the fallout in trade and business media.

Finally, never negate employee concerns. Bring investors or advisors in to explain the separation to your colleagues. If the co-founder’s departure is amicable, having them participate in some public separation process, such as speaking directly to employees, will squelch the rumor mill head on.

Handled well, a smooth separation process can invigorate confidence in a company for entering a new chapter. Mismanaged, it can unleash latent doubts and concerns around competency. You don’t want to send the wrong signal to customers and the industry at large. Confidence and trust are critical drivers for maintaining positive momentum.

In the long run, lean in toward the direction of transparency, honesty and forthright communication. FGD

Take Stock of Less Paperwork:

IRS eliminating individual filing of stock election form

The IRS is changing Section 83(b) of the Internal Revenue Code to eliminate the requirement for individuals to file an 83(b) election form with their tax returns. The form duplicates information the IRS already would possess regarding the distribution of stock an executive holds with an organization in which they have an interest.

Award and option holders used to have to file the election form by mail within thirty days of the triggering transfer (a grant of restricted stock or exercise of an unvested option). They also had to include a copy of the election with their individual tax return.

The IRS finally recognized that requiring taxpayers to file the form reflected an earlier era before electronic forms and scanners were commonplace. The inability of the IRS electronic filing system to accommodate the Section 83(b) election form necessitated a paper filing, causing inconveniences and errors. Nevertheless, taxpayers should keep a copy of the election until the statute of limitations expires for the corresponding return.

The change applies to all stock transferred (grants of restricted stock and exercises of unvested stock options) on or after January 1, 2016. However, taxpayers can rely on the change for stock transferred in 2015. Individuals will still need to file an 83(b) election within 30 days of receipt of property in order to make the election valid.

Even last year the IRS determined that a Section 83(b) election is still valid even if a taxpayer fails to forward an election form with their return. The change was motivated, in part, by the need to prevent a rescinding of an election by the taxpayer as a result of not including the form with their return. FGD

Litigation as a Last Resort:

ADR comes of age

As any executive leader and business owner recognizes, having to litigate in order to resolve a dispute or conflict is rarely an efficient process. Most trusted advisors will advise their clients to avoid litigation, whenever possible. It can be disproportionately expensive, time consuming, emotionally draining and unpredictable – especially when weighed against the overall negative impact of the situation that triggered the litigation in the first place.

Litigation outcomes are never guaranteed, no matter how confident you may feel in the legitimacy of your position. There are now clear and increasing advantages to choosing ADR (Alternative Dispute Resolution) approaches for acquiring a favorable outcome to your business conflicts.

The FGD team participates in numerous administrative hearings involving insurance, tax, state certifications and employment matters. We are seeing the ADR process being increasingly institutionalized as every matter proceeds to an informal first hearing. If the actual arbitrator or administrative hearing officer is present, he/she typically acknowledges what the ruling will be and directs that a settlement be negotiated. Dispute resolutions that avoid a lengthy litigation showdown are becoming far more standard and much less of an “alternative.”

A recent survey among senior in-house counsel of the Fortune 1000, a follow-up to the defining 1997 survey by Cornell University, found that more corporations have assimilated mediation into their management systems – along with other techniques to achieve early resolution of a wide range of conflicts and disputes.

According to the survey, corporations are becoming more sophisticated in how they resolve disputes, especially their use of ADR. This includes a greater emphasis on control of the process of managing conflict, such as neutral evaluation and early case assessment; approaches designed to deliberately handle conflict early on; and control over the selection of third-party neutrals.

These most recent findings are particularly compelling because they are not from service providers but poll counsel from the 1000 largest companies, regardless of their location or legal jurisdiction. Among the findings:

  • More companies use litigation selectively, and use ADR for most everything else;
  • More than half indicated that the use of ADR in corporate/commercial disputes was a contractual provision;
  • Companies used ADR in order to save time and money;
  • 98% of the responding companies had used mediation in the prior three years, and 66% had used early case assessment;
  • Arbitration usage has dropped for most dispute categories;
  • More companies reported using mediation for nearly all kinds of disputes.

Start up Right:

Don’t fail to ensure the accuracy of your EIN application

Every organization is required to establish an EIN or Employer Identification Number once the basic steps of legal formation have been completed. An EIN is unique to your business entity and identifies your company with the IRS.

EINs are typically required by the IRS for corporations, Limited Liability Companies (LLCs) and partnerships. If you are planning to hire employees you will need an EIN and banks required it in order to establish a business banking relationship and take advantage of the many services for businesses that banks may offer.

As a business owner, having an EIN number is also beneficial in separating you from having to disclose your personal security number in certain business transactions as a corporate identifier – such as on a license, permit and tax registration application. Along with an EIN, certain states require companies to also obtain a state tax ID number for sales and other taxes reporting.

While obtaining an EIN is a relatively simple task, many entrepreneurs and new business owners overlook the importance of ensuring that the EIN information is as accurate as possible. Here’s why:

  • The EIN determination letter is easy to obtain – right from an IRS online application. However, it is difficult and tedious to correct as the IRS does not have a form or process for amending errors. Applicants must draft a letter and send it to the appropriate department asking for the correction. What should take 15 minutes without errors could require 6-8 weeks if mistakes are made.
  • The EIN determination letter is often used in conjunction with the company’s charter/certificate to open bank accounts, register vehicles, and obtain loans and other credit facilities. The information on each form must match or the company runs the risk of being denied basic functions. An FGD client recently had this issue and was unable to register a vehicle it purchased because the information did not match. They ended up having to pay registration costs twice.

Client Highlights

FGD Law is working with Myomo, a medical device company specializing in myoelectric orthotics for people with neurological disorders and YoungStroke. The company has developed the MyoPro® myoelectric upper limb orthosis – a rigid brace that supports a patient’s weak or deformed arm to enable functional activities. The device is available through a physician’s order.

YoungStroke is an advocacy organization that specifically addresses the unmet needs of young adult stroke survivors and their caregivers. Through continuing medical education and community-based programs, YoungStroke raises awareness of the increasing prevalence of stroke among young adults and its devastating impact upon community life.

Some 30% of stroke victims each year are under age 65. The percentage exceeds 50% in certain regions of the U.S. where there is an increasing prevalence of risk factors such as hypertension, diabetes and obesity.

Myomo is collaborating with YoungStroke to expand awareness of its programs with conference presentations, social media marketing and research projects. Their joint intent is to increase available resources to the young adult stroke community – many of whom are veterans and active military, along with their caregivers. FGD

The FGD team is also working with Cognate Nutritionals, a company focused on research in food science that is originating convenient, functional foods that address common human health concerns. Cognate has pioneered the design and development of innovative nutritional products – including Fuel For Thought®. This first product is a liquid formulation of coconut oil that is vastly superior to the coconut oil products currently available on the market.

The company was established by Theodore B. VanItallie, M.D., and his colleagues who are highly regarded leaders in the fields of clinical nutrition research, food science and food engineering. Future new product releases will advance the company’s mission to target the public’s growing concerns with age-related cognitive decline and nutritional impairment. FGD

FGD Briefs

FGD Founding Partner Karin Gregory will moderate a panel for the conference, “Innovations in Health Law and Policy: Regulatory Challenges and Strategies for Change,” October 26, 8:30-4, at the University of New Hampshire in Concord. Presented by the Health Law and Policy Programs and sponsored by The Warren B. Rudman Center for Justice, Leadership and Public Policy at the University’s law school, the event will convene New Hampshire as well as national legal scholars along with policy experts.

The conference content will focus on state innovations in the health insurance marketplace along with legal and regulatory developments impacting health and bio technology innovation in the age of value-based care.

For information and registration, contact Lynda Troy at 603.513.5181 (lynda.troy@law.unh.edu).

FGD sponsored the annual Biddeford Ball that was held on Saturday October 3 in the main lobby of the Pepperell Mill building in downtown Biddeford, Maine. This year the proceeds went to illuminating the iconic brick smoke stack that defines the Saco/Biddeford skyline as well as increasing awareness and jump starting fundraising for the Biddeford Mills Museum.

FGD team member Eric Collins has been actively participating in a number of business groups including Mass Life Sciences Innovation Day, the Boston Alternative Investments Networking Group and the Dirigo-Getters in Maine. He also recently attended the MIT Enterprise Growth Forum event, “VC/Founder Newlywed Game”. On Tuesday, October 20th, Eric will participate in a workshop, ‘Equity Prep’ hosted by the Maine Center for Entrepreneurial Development.

FGD Law actively supports quality of life endeavors within the communities our colleagues live and work. The annual Biddeford-Saco ArtWalk is a favorite of all our team. The concept is based on Portland, Maine’s successful “First Friday”. The downtown group ‘Heart of Biddeford’ and other volunteers have grown it into an ongoing monthly event – taking place on the last Friday of each month, from April to October.Recently, FGD hosted artist Rhoda Melchiorre (above right) from Alfred, ME at the July ArtWalk. Here Rhoda displays her award winning mixed-media acrylic painting, “Global Warming” with FGD team member Eric Collins along with Jess Baxter.

FGD participated in the annual Business to Business Expo, produced and hosted by the Biddeford-Saco (Maine) Chamber of Commerce and Industry. The Expo was held at XL Sports World in Saco on September 16. Each year some 80 businesses join in this popular networking event, which is open to the public and includes guest speakers.

Founded in 1927, the Biddeford-Saco Chamber is an association of businesses, organizations and individuals committed to fostering a strong local economy and quality of life. The association’s programs seek to encourage tourism as well as attract people to live and work in the region. The Chamber is unique in that it is supported by sister cities that offer a diversity of businesses along with over 400 members including 32 communities and 4 states.

In addition to its long-standing membership, FGD continues a commitment to Chamber leadership as FGD Partner Don Furman currently serves as Second Vice-Chair.