You're excited about bringing on a new co-founder to help grow your startup. But then they propose something that makes you pause: they want a buyout agreement that lets them sell their shares back to the company at a 50% discount if they decide to leave due to disagreements. Your excitement quickly turns to concern as you wonder if this is a red flag or standard practice.
This scenario, shared by a founder on Reddit, highlights a critical question many startup founders face: Should you have a buyout agreement for potential co-founders, and if so, what should it look like?
Understanding Buyout Agreements
A buyout agreement, also known as a buy-sell agreement, is a legally binding contract that outlines the terms under which a co-founder can sell their equity back to the company or to other co-founders. Think of it as a prenuptial agreement for your business relationship - it sets clear expectations and protects all parties involved.
Why You Need One
The startup world is filled with stories of co-founder disputes and "business divorces" that turned ugly. According to startup founders' experiences, these situations can lead to "absolutely insane emails and phone calls" and protracted legal battles that drain both financial and emotional resources.
Common scenarios where a buyout agreement becomes crucial:
A co-founder loses interest and goes "completely MIA"
Disagreements arise about the company's direction
Personal circumstances force a co-founder to step away
Performance issues lead to necessary separation
The Risks of Not Having One
One founder shared their nightmare of having a third co-founder abandon the company without any signed agreements in place. This situation left them with "dead equity" - shares held by an inactive founder that provide no value to the company but dilute active founders' ownership.
Without a proper buyout agreement:
You might be stuck with an absent co-founder who still owns significant equity
Your company's future fundraising efforts could be compromised
Decision-making processes could become paralyzed
Potential investors might be deterred by the messy cap table
Key Elements of a Buyout Agreement
1. Vesting Schedules
A vesting schedule is your first line of defense against dead equity. As recommended by experienced founders, understanding vesting schedules is crucial for protecting your company's interests.
Typical vesting terms include:
4-year vesting period
1-year cliff (meaning no shares vest until after the first year)
Monthly or quarterly vesting after the cliff
2. Trigger Events
Your buyout agreement should clearly define what events can trigger a buyout:
Voluntary Departure: When a co-founder chooses to leave
Involuntary Termination: When a co-founder is asked to leave
Death or Disability: Unfortunate but necessary to address
Bad Leaver Events: Actions that breach company policies or agreements
3. Valuation Methods
One of the most contentious aspects of buyout agreements is determining the share price. Founders warn against agreeing to predetermined discounts that could drain company resources.
Common valuation approaches:
Fair market value determined by independent appraisal
Formula-based valuation
Book value
Agreed-upon value with periodic updates
4. Payment Terms
The payment structure is crucial, as many founders point out that "paying from future revenue is essentially agreeing to screw your future cash flow."
Consider:
Payment schedule (lump sum vs. installments)
Source of funds
Interest rates on deferred payments
Collateral requirements
Red Flags to Watch For
When negotiating buyout agreements, be wary of these warning signs:
1. Predetermined Discount Rates
Experienced founders caution that "a 50% discount buyout is basically a free ticket to be owed more cash than the company will have at any valuation." Such arrangements can:
Drain company resources
Create perverse incentives
Signal lack of commitment
2. Put Options
Startup veterans warn that "for them to have a put option is ridiculous." Most startups operate in continuous fundraising mode, and using funds to buy back shares is rarely considered a good use of capital by investors.
3. Lack of Performance Criteria
Buyout agreements should include performance measures that the company must achieve for full payout. As one founder notes, "You want the opposite incentive structure, where they only get the payout if the company delivers value."
4. Overly Complex Terms
Seasoned entrepreneurs advise that "most of what you'd put in a co-founders agreement is already covered by the standard set of startup docs." Be suspicious of unnecessarily complicated terms.
Best Practices for Implementation
1. Seek Legal Counsel
The unanimous recommendation from experienced founders is to "talk to a lawyer." Professional legal guidance is essential for:
Drafting enforceable agreements
Protecting company interests
Ensuring compliance with relevant laws
Avoiding future disputes
2. Use Standard Templates
Founders recommend starting with established resources:
Cooley Go's template library
Y Combinator's standard documents
Trusted legal platforms for startups
3. Consider Alternative Structures
Instead of traditional buyout agreements, consider:
Reverse vesting provisions
Right of first refusal clauses
Tag-along/drag-along rights
Performance-based vesting acceleration
4. Regular Reviews and Updates
As your company grows, regularly review and update your buyout agreement to ensure it remains:
Aligned with company valuation
Practical to implement
Fair to all parties
Compliant with current laws
Conclusion
A well-structured buyout agreement is essential for protecting your startup's future. As one founder wisely notes, "I think they should become a staple. No bullying or abuse clauses. If one cofounder is going to leave, give back some equity etc. agree to who is CEO and everything that comes with that."
Remember:
Standard agreements exist for a reason
Seek professional legal advice
Watch for red flags in proposed terms
Focus on incentivizing long-term commitment
Protect company cash flow
Regular reviews and updates are essential
By implementing these guidelines and learning from the experiences of other founders, you can create a buyout agreement that protects your company while maintaining healthy co-founder relationships. The goal is not just to plan for potential departures but to create a framework that encourages commitment, fairness, and long-term success for all parties involved.
