Defoundering

How to Avoid Being Pushed Out of the Company You Founded

The relationship between startup cofounders is not unlike a marriage. And like marriage, many end in divorce.

denveen1 How to Avoid Being Pushed Out of the Company You Founded

Denveen. (Illo: Jessica Roy)

Mr. Crowley also declined to give a comment at the time, but issued a tweet: “After 3 yrs, my @foursquare co-founder is moving onto new projects & big ideas. Can’t wait to see what’s next @naveen!” Foursquare, Mr. Crowley and Mr. Selvadurai declined to comment for this story.

Founder ouster—or defoundering, if you will—is hardly new, and it doesn’t often go smoothly. For instance, Jack Dorsey, cofounder and CEO of Twitter, was reportedly pressured to leave in 2008. Mr. Dorsey and Twitter’s other two cofounders played musical chairs with the executive roles and board seats until Mr. Dorsey resigned himself to chair Twitter’s board and focus on his new company, Square, of which he declared he would be CEO “forevermore.”

The most famous example of defoundering is Steve Jobs, who sidelined his two cofounders at Apple, then got sidelined himself—only to stage a triumphant return. The second-most famous may be in The Social Network, when Eduardo Saverin puts a little too much faith in his Harvard economics concentration and signs some papers without a lawyer, only to see his shares diluted to insignificance. (The dramatization suggests Mr. Saverin’s 24 percent was watered down to .03 percent, though the real-life Mr. Saverin managed to come out of his Facebook dealings a billionaire.)

The best hometown example may be that of the ginger-haired, freckled Brooklyn carpenter Rob Kalin, at the time in his late 20s, who blew investors away with his minimalist presentation about Etsy. The six perfect slides became a minor Silicon Alley legend, and Etsy raised more than $30 million while Mr. Kalin was at the helm. How disheartening it must have been when the same investors decided he wasn’t “scaling the business” efficiently and needed to be replaced.

The board swapped the founder out for COO Maria Thomas, a former NPR executive. Within two years, Mr. Kalin “led a rebellion,” as one person with knowledge of the situation put it, and got himself reinstated. He was defoundered again less than two years later. “As Rob transitions out once again, I want to personally thank him for all of this and more. Etsy is his creation and will always be,” Etsy investor Fred Wilson wrote in a blog post, as if he’d just come from putting an agitated toddler down for a nap in the next room.

Mr. Kalin did not make a statement. If he had, he could have stuck up for Chris Maguire, Haim Schoppik and Jared Tarbell: Etsy actually had four cofounders, which the startup creation myth, which favors singular genuis, had simplified to one. (Mr. Tarbell is the only one left at Etsy, where he is a Flash developer.)

Ironically, it often seems to be the technical cofounders who get left behind. In the beginning of a startup’s life, it’s the technical cofounder who is coveted; but as a company grows, it attracts developers fresh out of school who are steeped in the latest trendy new framework. Mark Zuckerberg built the original Facebook himself. But when he decided he wanted to code a few lines for Facebook Groups, he found he’d lost his touch. “It took him like two hours to do something that would take one of us who’s an engineer like five minutes,” one Facebook engineer told New York magazine.

Nevertheless, nudging out a founder out can seem cruel. “For a while, [Denveen] were going back and forth for a while about whether there was a good fit for [Mr. Selvadurai] and a good way for him to stay at the company,” a second source close to Foursquare told Betabeat. “In the end they both agreed that there wasn’t a place for him. It’s definitely an emotional time. People internally are sad… but I think everyone understands why they decided that was the right move.” Things just changed.

All’s fair in love and business, of course, and cofounder fallout seems to be hardwired into a startup’s development. One New York-based investor and entrepreneur, who didn’t want to give his name because his new company has not launched yet, told us it took 90 days trying to draw up documents that were fair to his junior cofounder and that his investors could sign without marking up. “What I found is that a lot of the kind of hurt feelings and distrust and things that you’re seeing at Foursquare right now are kind of baked into the organizing structure, into the documentation that holds these companies together,” he said.

For his startup, the entrepreneur said the process of negotiating with his own lawyers over the company’s structuring documents has already cost him $26,000, and that’s just for a third of the total bill. 

Buried in those documents are booby traps for founders, the investor-entrepreneur said. He recalled a morbid clause in the standard term sheet. If a cofounder dies, lawyers expect the company will want to recapture the shares rather than let the stake go to the next of kin. The investor-entrepreneur was dubious. “I’m like, wait a minute, let me get this straight. This guy works with me on this company for three years and everything is great, and then he gets killed in traffic, tragically… I’m reserving in these docs the right to give his wife and the rest of his estate nothing? Like, that’s my negotiating posture? I don’t want the right to screw people.”

Lawyers tend to write in every possible downside scenario to cover themselves if the company goes south, as so many startups do. Few bootstrapped 24-year-olds would decide it’s smart to hardline the people who want to give them millions of dollars; most startups take off-the-shelf paperwork with standard terms, make a few tweaks and sign in six weeks.

But perhaps founders should think harder about how to protect themselves on the upside. It was reported that Mr. Selvadurai hired lawyers to try to fight his departure; then again, one always hires a lawyer in these situations. “The culture is antagonistic,” the investor-entrepreneur said. “Again and again you see that often the founding group can be eclipsed by the one guy who ends up being associated with the success. People get pushed and shoved around. Because the mythology about entrepreneurial success doesn’t really include that in the story, people don’t plan for it.”

We consulted with Matt Blumberg, the founder and CEO of Return Path who wrote the “Entrepreneur’s Perspective” section for the widely-circulated book Venture Deals, an introduction to startup dealmaking written by investors Brad Feld and Jason Mendelson. “As an entrepreneur, it’s always a painful thing to hear about when a founder gets pushed out of his or her company,” he wrote in an email.

Mr. Blumberg was surprised to hear that Mr. Selvadurai had left Fourquare. “I don’t know those guys,” he was careful to say, but in his experience, “the job just totally changes as the company gets bigger.” Even Sergey Brin didn’t really scale with his company; while Larry Page runs Google, Mr. Brin tinkers in his own department on special projects.

“I think it’s easy for people to jump to the side of the founder against the big bad investor,” Mr. Blumberg said. “But we’re all grownups and you sign the papers you sign.”

But what about founders’ rights? we asked.

“I’m not sure I feel like there is such a thing,” he wrote. “The most important two things a founder can do to protect himself against being ousted are (a) do a world class job at being CEO, and (b) select great investors and partner effectively with them.”

But surely there must be some way to guard against defoundering, we imagined. Some sort of cofounder prenup, perhaps. We pinged David Sorin of Sorin Royer Cooper, who has been ministering to startups for more than a decade.

“While a founder can protect his or her economic interest with appropriate contracts and provisions, once a company has institutional investors and an independent Board of Directors there is no way to prevent the possibility of a termination or separation,” the attorney wrote back.

In an industry where a company can go from zero to $600 million in three years, it would be naive to expect otherwise.

>> DENS & NAVEEN SPLIT! [SLIDESHOW]

A version of this story appeared in the New York Observer the week of March 14, 2012.

Follow Adrianne Jeffries on Twitter or via RSS. ajeffries@observer.com