Starting a new venture with a co-founding business partner or fellow company director is an exciting journey. Unfortunately, however, starting a business together does not always work out. Due to professional disagreements or personal differences, co-founders sometimes go their separate ways into separate businesses. If your former co-founder starts a competing business, it can be difficult to know: 

  • what you are legally entitled to do to protect your interests; and 
  • what the law restricts you from doing, particularly regarding the transfer of information and client relationships. 

This article will explain what you can and cannot do if your former co-founder starts a competing business.

Common Situations

Although your situation will be unique, many business founders have experienced this situation. You may decide to part ways if:

  • you and your fellow co-founder believe the business should go in different strategic directions; or 
  • there are issues with your working relationship and you decide to part ways.

Having a clear understanding of your legal relationship before separation is important. Two of the most common methods of structuring a business – as a partnership or as a company – will require founders to split up their venture in different ways.

Leaving a Partnership

A partnership cannot exist without at least two partners. If one leaves, therefore, the partnership ends unless a new partner buys out the departing partner. Any property is shared between the partners. If your partner leaves and is not replaced, the partnership is dissolved. The events that follow may be governed by: 

  • a formal partnership agreement; or 
  • the relevant laws in your state or territory.

It is important to have a clear understanding or written agreement about how you will divide the property of the business (the ‘assets’) before a dispute arises.  

For example, one partner could buy out the other for an agreed amount or an amount determined by a valuer. Alternatively, the business could be sold and the proceeds divided up. 

You should consider how the partnership will be dissolved before entering into the partnership, to ensure minimal confusion if a dispute occurs.

Leaving a Venture Under a Company Structure

A company, as a separate legal entity, can still exist when the directors or shareholders change. As long as one director remains, it can also continue to exist if a director resigns and is not replaced. If your fellow director and shareholder leaves, you may need to take additional steps in order for them to part with their formal ownership in the company. This may be affected by:

  • your company constitution; or 
  • a shareholders agreement, if one is in place.

If neither you nor your co-founder wish to be involved in the business at all, then you may decide to deregister your company.

Dealing with a Co-Founder’s Competitive Business

If you and your former co-founder parted ways on good terms, you may have less reason to be concerned that they will compete with your business. Regardless of the current relationship, however, there are a few key areas that you should look out for to make sure that the competing business does not affect your rights and the future of your business. You will need to consider your:

  • intellectual property;
  • business relationships; and
  • employees.

Intellectual Property

The intellectual property of a business may be comprised of a wide range of assets, such as:

  • a particular product design;
  • brand names and logos;
  • business secrets and formulas;
  • website domains;
  • customer databases; and
  • programming codes. 

If you had a partnership, you and your co-founder likely owned the intellectual property jointly or in different portions relative to your share of ownership of the business. If you had a company, the company most likely owned the intellectual property.

You should find out whether you and your co-founder’s competing business are using the same intellectual property. Alternatively, the original business may need to keep it exclusively. If you agreed on how the intellectual property was to be shared between you, is your former co-founder complying with the agreement? 

For example, if you agreed that one or neither of you would use the former businesses’ branding, are you both complying with this? If not, there are legal ways you can address breaches, such as negotiations, demands or an injunction.

A cease and desist letter is a formal letter of demand requesting the recipient to stop doing something, such as using intellectual property. It sets out further steps you may take if they do not comply. If the recipient of a cease and desist letter does not comply, you may need to consider an injunction.

Business Relationships

Your database of customers, clients and suppliers is likely to fall within the intellectual property of the business if they are kept secret. As well as this information, it is crucial to consider your other business relationships. This is especially important if your business had long-standing or exclusive agreements.

You may need to enforce an agreement with your co-founder regarding:

  • non-solicitation of certain or all clients;
  • the sole rights to any exclusive supply or distribution agreements; and
  • restrictions on communications with shared suppliers.

‘Solicitation’ means contacting someone for business, so a non-solicitation obligation typically refers to an agreement not to contact a supplier, client or customer.

Employees

When a competitor business emerges, particularly one started by a former co-founder, it is possible that some employees may be interested in moving across to the new business. This may be the case for professional or personal reasons. Whether your employees can move may be impacted by any restraint of trade clauses in their employment contracts, but this can be a difficult area to navigate.

Two important questions to ask yourself are whether:

  1. the employee moving across is a core component of your business; and
  2. your former co-founder enticed (i.e. solicited) the employee to move over.

If the answer to both questions is yes (or even to the first one alone), then you may wish to look into the possible ramifications of the employee’s move. It may not matter to your business if your former co-founder has enticed an employee who is not crucial to your business. However, a senior employee might take with them a lot of business knowledge. It is important to be clear about what knowledge can and cannot be used by a former employee if they move to a competitor.

What Can I Do About it?

If your co-founder’s new business is competing with your business and you believe that they have done something in breach of an agreement or the law, you have three options. You can:

  1. ignore the problem;
  2. negotiate a resolution; or
  3. take legal action.

1. Ignore the Problem

Although doing nothing might not sound like a viable way of enforcing or protecting your rights, it may be in your interests to leave things be if the impact on your business is insignificant. It may be more beneficial to invest time, energy and financial resources into growing your business past the point where the competition is a problem. 

Considering the commercial realities of these situations can be challenging, but dealing with practical solutions will help you become a better business owner.

2. Negotiate a Resolution

If you and your former co-founder are still in communication, it may be wise to try and resolve any issues in an amicable manner. Perhaps the terms you originally agreed to are not as fair as either of you thought or are no longer practical due to a change in circumstances. One of you might want more ownership or rights and be willing to offer some form of compensation in return.

Opening the lines of communication to enable these conversations can save both of you a lot of stress. More importantly, it can lead to a better division of resources and property. This approach can help to preserve or improve the existing relationship. However, it can also create tension if the negotiations are unsuccessful.

The aim of negotiations is to reach a resolution that benefits both parties, rather than a compromise. For example, rather than split two assets evenly, it may be better for each of you to take one completely and get more value out of the asset.

3. Take Legal Action

If the above two methods are not viable for your particular situation because the problem is too serious or the relationship with your co-founder has deteriorated, you may wish to consider legal action. 

Making a formal demand with a cease and desist letter can be an effective way to start the process towards more serious legal action, while still allowing space for a compromise-based resolution. It also clearly sets out your position and allows for an airing of your relative legal positions. Taking legal action will often have a detrimental impact on your relationship, and so you should consider this path carefully before proceeding.

Before taking such a formal step, it is important to weigh up your prospects of success with the financial costs and risks of taking legal action.

Key Takeaways

As co-founders, going your separate ways may be part of the natural lifecycle of your business. Nonetheless, it can be complicated to manage. A lawyer can help you to understand the circumstances and reach an outcome on how you will divide the valuable assets of the business. If you have any questions about a former co-founder’s competing business or your rights if you wish to leave a venture, contact LegalVision’s Commercial Dispute lawyers on 1300 544 755 or fill out the form on this page.

About LegalVision: LegalVision is a tech-driven, full-service commercial law firm that uses technology to deliver a faster, better quality and more cost-effective client experience.

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Cameron Graf
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