On The Psychological Side Of The Legal Aspects Within The Entrepreneurial Journey - Part 3

Guy Lachmann,
Senior Partner, Pearl Cohen Law Firm

This series on the podcast discusses the psychological aspects intertwined with the legal aspects of the entrepreneurial journey - and most importantly - the founders' agreement, choosing a lawyer and the case of separation between partners.

>>> "And after all, in spite of everything, it’s over…"

Separation of entrepreneurs happens more than people think. In most cases - it also doesn’t end in explosions, but in a relatively friendly parting.

The infrastructure is very influential - if there’s no founders’ agreement - everything is legitimate, there’s no ability to know what will happen. When there are contracts drafted by an attorney - you can moderate the effect and come out in a way that the company survives. There are also cases where the separation pushed the company forward significantly - something that also benefits the entrepreneur who left, and also cases where there was a separation intention, things worked out, the entrepreneur stayed, the founders overcame the difficult situation - and the company made a significant leap forward and was very successful. When it comes to separation and crisis - dealing with a raging ego with maturity is required. There are cases of elegant parting alongside cases where everything explodes.

>>> How involved are the entrepreneurs?

I talked with Guy about the "company’s good" test I like to use, borrowed from the "child welfare" test when family laws are on the table. When I work with entrepreneurs and there are small and big disagreements that cause quarrels and an inability to act and move - I believe an honest look at the good of the company - helps bridge the gaps and bring the entrepreneurs back to where they came from - how to help a company that they care so deeply about to grow. We ‘ll look at it with radical honesty - it will help us shed a lot of light on our dilemmas. Of course - the responsibility for the benefit of the company rests on the shoulders of a lawyer legally, but entrepreneurs have a significant part in the ability to allow this to exist.

Remember that "A gun that appears in the first act of the show, must fire by the end of its last"? The same deal goes for entrepreneurs. We talked about how after seeing dozens and hundreds of entrepreneurs - we have adapted a very sharp ability to see things that will develop along the way, and discussed the question whether it’s right to signal this, for example - when you feel signs of problems that arise between entrepreneurs that may lead to bad places? - when an entrepreneur comes to the point of leaving the company, and as an attorney or adviser you saw it coming a long time ago? So there’s a question of whether to divert their attention or not. Sometimes, a certain statement can also escalate the situation.

The way is to reflect what you see, and let it resonate, while developing an elegant ability to maintain balance.

In principle - the company hires the services of an attorney, not the sole entrepreneur, and therefore, an attorney should be neutralized from the preference of a specific founder. But - this isn’t always true and takes place in practice. Officially - it’s very clear who they represent, but in reality - it’s different.

Advocates have rules of ethics and should be very strict. They must not be in a state of conflict of interest - you can’t choose a side. Sometimes, precisely because we have maintained ourselves as neutral - it has gained trust and appreciation and can help finish nicely and try to bridge between the parties. Advocates are supposed to represent the company and not do 'The Judgment of Solomon'. This is a moral and ethical question, and an attorney cannot advise only one party, let alone on the basis of an agreement that the attorney drafted. This means that in any situation of potential conflict of interest - lawyers are inclined to alert the relevant parties and obtain their written consent on how to proceed, assuming they wish to continue their representation. On the other hand - it’s important not to get stuck, and try his best to use the fact that he is an acceptable figure on both sides to motivate them to a common goal.

“Sometimes being an attorney in a mediator’s hat is a slippery slope to a conflict of interest. Sometimes it‘s right for each party to take a lawyer - and let them try to reach agreements in a healthier and more balanced way. Sometimes there’s a "stronger" founder and then it’s easier for the lawyer to get confused, and sometimes the lawyers fortify their position and then there’s an unwanted procrastination. There has to be a neutralization of emotions for helping the client reach the desired result - and not necessarily to want to be the winning attorney. Helping the client - is to end nicely and also take into account the mental costs that accompany the legal battle."

One has to remember - if we bring the company to a situation that is unfundable - then no one has won. Flexibility and understanding of how the company will win in the end must be produced and be taken into consideration. Otherwise - the departing entrepreneur who insists will be harmed. It’s best to go out in a way that will maximize the company’s chances of success.

The parting discourse requires a lot of maturity, psychological stability and ego in proportions.

Sometimes passion / creativity / enthusiasm are what helps the success as an entrepreneur - and sometimes that's what stumbles them - when they don’t know how to manage it in a more held and complex discourse.

An example where a startup was into an A round of $20M and had 3 co-founders. At the same time, the struggle for decision-making began. Then, the CTO resigned. It was catastrophic for the company, since he held ⅓ of it. The term sheet was pulled back, one fund ran away and the other fund agreed to invest in a lower valuation. The same CTO blew up the matter.

On the other hand - what happens when there are bad vibes and an entrepreneur feels he has to leave. Do you stay until the recruitment ends?

Things are coming to the surface. The tension will be visible to new investors. Sometimes the departure also raises the value of the company - because the tension is resolved.

Most importantly - don’t leave by slamming a door. It's childish.

Departure should be consensual, with a clear contract, understanding, to produce stability after departure. To allow a departure that will not create a scar on the outside and prevent the company from raising money or hurting its value, or a case where the leaving founder will create opposition to the company and prevent it from being attractive.

It’s important that both parties - the leaving and the remaining one, will create a separation that will be decent, fair and logical. Over Insistence on the terms of departure - can sabotage the company. Up to 10-12% equity to be left in the hands of the leaving founder - it makes sense. Make sure the number is not too prominent in the cap table. On the other hand - also don’t give degrading offers - where the founder drops from 50% holdings - to 0.5%. A humiliating offer evokes the ego, and then there’s a fortification in the position - "I'm not talking to you", and the entrepreneur can get up and go and there’s no way to enforce it, then he will have to get a waver before any deal or investment and that complicates the matter.

If there’s an orderly founders’ agreement - then everything has already been agreed there.

Healthy departure - is a complete departure, not even staying on the board. The real meaning of leaving is to let the company you are leaving all the tools to be hugely successful.

It’s important to mentally process the departure - both for the leaving founder and for the remaining one, to prevent producing a kind of post-trauma in the future. It’s clear that those who leave have great complexity to process (and sometimes also great relief and well-being), but those who remain - have to deal with continuing the daily tasks, the lack, the consequences, the feedback from employees and the feeling of loneliness - that along with relief, can also produce a very great emotional burden. That’s why it’s important to talk about it, unload it, process what happened and move on from there. I often meet entrepreneurs in their second 'round' - who carry with them post-trauma from the way they were thrown away, left or were abandoned on their own in their previous startup, and it runs them and affects their whole relationship in the new venture.

>>> What is the place for investors in parting?

Investors can play a critical role in a breakup. There are entrepreneurs who "asset" a certain investor to themselves - thus putting pressure on the other side. It should be remembered - that when one side chooses to put pressure on the other side in front of the investors - this is a double-edged sword that can both damage the reputation and can have a boomerang effect if the investor chooses to go with the other side.

The investors can be a pressure factor that helps reach understandings, often much more than mediation. On the other hand - if investors don’t see eye to eye - this is a recipe for destruction. The position of investors is greatly influenced by the outcome that will protect their investment to the maximum. Sometimes an investor starts with one founder - but then becomes more "pro" of the other founder - because he thinks he can bring the company forward.

Investors should express their position and not sit on the fence - but they will usually take the economic position, which can be difficult and produce a "cruel order" - but such an order can prevent the market failure that the startup may run into.

In conclusion,

It’s crucial to have a good lawyer by your side that is attuned to you from the very first moment. And as my late father would say - and better one hour before.

Disclaimer (I am after all still an ex-attorney) - everything that is written in this series of three chapters is in the nature of providing knowledge that will help you shed light on the field and reflects our perspective and worldview, and is not a substitute for personal legal advice for you. Guy and I recommend you consult a lawyer If the topics of the podcast are relevant to you before taking any action. Each case should be examined on its own merits and its individual aspects weighed. The conversation is meant to give you a general impression and is done on the opinion of the speakers only.

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