Handling Succession of First-Time Founder CEOs

When investors replace a first time founder CEO to take the company to the next level, founder should negotiate protections to his stock, position, succession.

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Mass High Tech , August 24-30, 2007, Page 13

By Robert A. Adelson

Are you the first time founder of a successful startup company?

Are you an employee, investor or director in a successful startup still led by a first-time found CEO?

Is there concern that the skills needed for successful launch may not suffice to reach the next level of growth?

In early-stage companies, a founder’s success often speeds his or her replacement b a professional CEO to lead the next phase of growth of consolidation of existing growth.

The company’s success in meeting its first milestone plus its need for new capital to feed growth – to capitalize on opportunities present – often speeds a change at the top. Venture capital investors often condition funding on commitment to hire a professional CEO to lead the next phase of growth.

In mature companies, achieving revenue, profitability and market share assures the CEO’s income and viability. Paradoxically, the reverse is often true for startup founder CEOs.

The founder of CEO’s passion, vision and willingness to take risks, essential to the startup’s launch, are felt no longer needed to take the venture to the next stage. VCs now look to a proven ability to sustain infrastructure and organizational growth, to communicate, interface, harmonize and energize investors, directors, the media and other parties.

First-time founder CEOs may feel they can sustain growth, but investors in A and B rounds often require experience, a track record in scaling ventures to liquidity, before they will invest millions of dollars to fuel the next stage of growth.

The first-time founder seeking capital needs to recognize CEO succession is likely, perhaps inevitable, and take actions that benefit founder and company whether or not such succession occurs.

The first-time founder should build a strong board that includes independent, technology-savvy directors. Even as an investment comes and investors’ preferred stock terms exert a level of control, investors should not overload the board. It’s best to have an independent majority of industry representatives who can also empathize with the founder-CEO with a minority of VC members of the board who can offer input but not control the direction of the firm.

In taking investment, it’s wise to choose character over cash. Instead of focusing on valuation, spend time evaluating past investments in the field, experience and judgment. Even if the investors want a profession CEO, what input will the founder have? What will be the composition of the board? Founders should read the signs to be assured of mutual respect.

The first-time founder CEO also needs to protect himself – to assure legal and contractual protections for his post-CEO business position with regard to the company he directed.

Carry protection

Basic protections to seek with succession include these

  • Minority shareholder protections including for information, against dilution and cast-out rights;
  • Exercise rights over options, vesting of shares;
  • Board representation or observer rights;
  • Role in successor selection and transition;
  • Post-employment paid consulting;
  • Back licenses of technology, office support;
  • Severance pay, post-termination benefits and coverages;
  • Negotiation of noncompete, nonsolicitation, other restrictions

When to seek protections? As soon in this process as possible. When the Series A or Series B investors condition funding on hiring a successor CEO, the founder CEO then needs to set terms for his own protection.

Succession is a two-way street. The founder shows himself a “team player,” sharing with the investors the goal of making money. It’s about success not power. Yet, just as the founder shows his willingness to yield power to everyone’s financial gain, that’s the time the founder to achieve protection for his own stake in that financial gain.

For both founders and the company, careful planning including appropriate legal counsel improves the chances of the founder’s consent to succession and successful transition of the successor CEO.

Additionally, for the founder who built the company, it’s important to have your own counsel skilled in these matters. Having your own counsel focused on your interests and engaged early in the process improves your chances of avoiding the King Lear situation where all you built is owned by others and you, left with little recourse, to guide the enterprise or protect the investment of money, sweat and years of your life that went into creating the company that was once your baby.

Robert A. Adelson is a partner at Engel & Schultz, LLP of, Boston. A corporate, tax and employment attorney for more than 25 years, Adelson represents founders and  entrepreneurs, employees and executives, companies and independent consultants.

The attorney and author of this article can be reached at (617) 951-9980 or radelson@engelschultz.com

(c) 2007 Robert  A. Adelson

Author: radelson

Robert Adelson has been a corporate and tax attorney since 1977. He began as an associate at nationally prominent New York City “mega” law firms, first at the Wall Street firm Dewey Ballantine Bushby Palmer & Wood and later at the Park Avenue firm Weil Gotshal & Manges. In 1985, Adelson returned home, where he has since established himself as a respected Boston business attorney. He has attained partner at several small and midsize Boston law firms, most recently at Lawson & Weitzen LLP and then Zimble Brettler LLP, where he was a partner from 1994 to 2004 before becoming a partner at Engel & Schultz LLP.

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