Timo Kullerkupp: contracts need to be discussed, not just signed
RASK partner Timo Kullerkupp was recently interviewed by Tehnopol Startup Incubator. The interview focused on the main problems and their causes which often end up fatally for early-stage startups, arising from relations between the founders. On a daily basis, Timo’s involved in advising technology companies. As a mentor to the Tehnopol Startup Incubator as well as several other accelerator programs, he has witnessed a variety of difficult situations and heated quarrels between startup founders.
We are happy to share the initial interview, translated to English.
>> The original interview, in Estonian, is linked here.
Q: How often do you have to deal with start-up founders who have fallen out?
Quite a lot. A fall-out may not even be the right word, it is rather misunderstandings. There are quite a few of these inherent misunderstandings and conflicts programmed into founder relations. There are many roles, many functions that founders have and that in itself is complicated. Additionally you need to get on with other founders and third parties. The most important and the most risky relation of them is in fact not between the founders but, between the founders and the company. From time to time situations arise where one or another founder finds that he or she has some rights to the assets of the company – because the person takes himself or herself to be the essence of the company. If there is an ABC of things not to do, then this stands at A: Do not confuse yourself with the company!
In many cases, at some point, one founder perceives that he or she is contributing more than others, or that he or she has simply earned more than others and therefore possesses the right to gain more from the company and its assets. This is a type of situation where eventually everyone loses motivation. And in the case of an early stage startup, it can also be called “the end”.
The main problem is that founders do not talk to each other about these things. There is too little talk in the beginning about what the company needs, what one or another founder can bring to it, what are the common goals and also the solutions in case a problem arises or when life simply takes its toll on building the start-up. It is quite typical to start with great enthusiasm, but further up the road, one of the founders simply fails to contribute the hours - whether there are personal financial reasons or life has made some kind of a twist and that is why he cannot contribute as much as intended, as much as needed. As a result, treatment of founders will no longer be equal and, if they have not talked beforehand and it is not clear what the consequences are in such situations, there will be conflict and a lack of motivation inevitably follows. If a startup has no motivation or ambition, then there is no startup.
Q: Faced with companies from many different areas of activity, do you think start-ups are any different in terms of founder/shareholder conflicts? In this business format, are founders more likely to get into conflict?
In my opinion, the legal issues are, in fact, very similar for all companies, just the focus is different. In the case of start-ups, the situation is complicated by the fact that there is no steady cash flow. You constantly need to balance: how long your runway is, where can you spend the little money that you have. The daily stress over money is much higher for start-ups than for established companies - there the focus issues are different.
Q: Please give some examples of conflict situations between founders
Here´s one example of a common scenario: the company has been active for a year, they have three founders, they all have a defined role and a clear purpose for being where they are, everyone has their own personal qualities and knowledge. However, one person gets an amazing employment offer from a large corporate. There you have it. It is now time for him to leave the company – it is clear that some work has been done and a lot still to do. How do you solve a situation such as this? If he takes all his shares with him and leaves the company, the company does not have the financial resources to recruit any talent and pay top dollar for it. The only real consideration the company can offer the joining talent is the same shareholding that the leaving founder had. If this goes away with the leaver, the company has nothing to offer and there is no one to perform the tasks that are critical to its success.
As far as abuses are concerned, it still happens that when a company has received its first or second investment then someone is tempted to buy a computer for personal use or incur some other expense that is not really necessary for the company, but rather serves the founder himself. In many cases this leads to loss of trust between the founders, and the relationship that is so important for the startup´s success, is broken. Founders fall out and trust is lost: for if you have once misused the company credit card how can the others be sure you will not do it again?
The founders have a lot of different roles when they build their start-ups. They have to understand that their roles are different and that their responsibilities in these roles must be different. One must not put an equation mark between themselves and the company. It must be understood that other shareholders are, so to speak, on an equal footing. And it is actually the privilege of the founder that through his role he can shape the activities and development of the start-up, to make it something bigger than one is alone.
Q: How are such situations usually resolved?
Mostly through liquidation. If we really are talking about a loss of trust in a start-up, where the pace of work and development must be massive in order to get somewhere, then this cannot be coped with if you do not trust your co-founders.
Luckily, there are also cases where the situation has been clarified and expectations have been restated, the original agreements have been fundamentally changed and we have been able to move forward together. In general, however, if there is a lack of trust due to the fact that there has not been enough talking at the beginning, then the company will break up and a new person will have to be found to take on take the role of the leaver. If anything can be salvaged at all.
Q: Who usually loses in this situation?
The company, start-up, the idea. In fact, everyone is a loser, there are no winners.
Q: How is it in general? Are the opportunities to defend oneself used too sparingly?
They are used formally. There are very nice templates for shareholder level regulation and founder relations available. It is great that start-ups know they exist. But they sign them largely in such a way that they do not know their content and have not really discussed the underlying issues. My suggestion is to take the topics from the documents, sit down, take the time and go over these issues in great length and depth. The contract is ready to be signed when you have reached a clear understanding between each other. These templates are very general and provide some protection, but may not be suitable at all for the people who you actually work with. There is quite a lot of worldview and values that should, in fact, be reflected in the shareholders' agreement to make this thing successful and sustainable.
Q: In June, you gave an interview to Tehnopol outlining the three most important agreements. One agreement you certainly cannot do without was the founders' agreement. Is it the founders’ agreement that sets forth these solutions?
Yes, the founders' agreement should certainly clearly reflect these solutions. Often, however, in the euphoric beginning, the founder's attitude towards the matter is similar to the situation when signing a standard contract with Elisa or Telia: you never read the terms of such agreements. You know you need it to get that phone number, and you sign, and if there's a problem after that, there's a lot of confusion.
Startups also know that they need a founders' agreement, but they don't quite know why and what should it regulate. I recommend using legal counselling. It may only take 15-20 minutes for someone to explain why it is important to fully understand where you stand and what are the possibilities and why it is important that your views are really reflected there, not just what someone thought worthwhile to put in a template.
Q: What are the opportunities for start-ups to protect themselves from such conflict situations?
The agreement provides these opportunities. There is also law, but above all the law protects the company and its sustainability. The shareholders' agreement should fundamentally be constructed on the same principle, so it monitors the success of the company and provides the necessary resources, including for the founders. It should not focus on the rights of various founders, but ensure that the company has everything it needs to succeed. If the company is successful, the founders will also ultimately benefit from it, as they can make a good exit or attract investors and build a business they can be proud of.
Measures to protect oneself are, in legal terms, rights of action by which you can demand action from another person.
A good founders’ agreement is one which you have thoroughly negotiated and which you never have to take out of your drawer after signing – because everyone knows exactly how things work, without any need to look it up.
Q: Where is the essence of the problem then? Why are the legal means to protect oneself from such situation used so little? Why are contracts made superficially?
The point is simply that the business itself, its development or the attempt to launch is top priority for startups. And it should be. Unfortunately, there are other important things as well you cannot do without. It is a question of resources and awareness. The agreements referred to in my previous interview are made and signed, but mostly just to tick the box. There is no substantive understanding of them.
Q: Legal advice is generally a luxury for startups, especially at the beginning - how should they be able to afford legal counselling?
It is no luxury. First, many legal tools are available for free. In general, lawyers themselves are happy to use such tools and for the most part they do not charge money when using them. A fee is taken when advising and negotiating, but overall if you consider what you get out of it, then it is not expensive at all. The main matters can be clarified with very little time spent.
In addition, we have incubators through which it is possible to gain access to high-quality legal assistance on very favourable terms. Many law firms also offer their own packages and benefits to start-ups in order to help them get up and running faster in the beginning. Lawyers do not view the relationship with the start-up on an hourly basis, they also like to take a long-term view and grow with the client. And they like it when their clients are successful.
This preconception that legal aid is expensive and a luxury good needs to be forgotten. Lawyers are definitely worth a visit. The lawyer will make an intro , explaining the terms beforehand and if these still seem expensive you can either ask another lawyer or try without. Considering how many obstacles and problems are removed from the outset, I think a lawyer is a very reasonable investment.
Q: I imagine that you have seen all sorts of situations in the relationship between founders. Can you offer some general tips on how founders can maintain good relationships with each other, what is the backbone of a good relationship hygiene?
The most important keywords are honesty and openness. From the very beginning, you have to be honest with yourself and others. See and talk about what someone's role is, expectations, opportunities, how much someone can contribute. If these issues are discussed honestly and openly, there will be far fewer problems in the long run.
Timo Kullerkupp - Head of Technology at RASK.