When a Co-Founder Leaves: Legal Playbook for Managing Founder Departures

Co-founder departures are one of the most common — and most disruptive — events in a startup’s life. Research consistently shows that founder conflict is a leading cause of early-stage failure, and even when the departure is amicable, getting the legal mechanics wrong can create problems that follow the company for years: a messy cap table, unresolved IP ownership, a disengaged shareholder sitting on a significant equity stake with no obligation to contribute, or — worst case — litigation.

The good news is that most of this is manageable if you’ve set up the right structures in advance and follow a clear process when the time comes. Here’s a practical legal playbook for handling a co-founder departure under Australian law.

Step 1: Check Your Documents

Before anyone does anything, pull out your foundational documents and read them carefully:

• Shareholders agreement. This is the document that matters most. A well-drafted shareholders agreement will contain leaver provisions, vesting schedules, pre-emptive rights, and a defined process for what happens when a founder exits. If you have one, it should answer most of the questions that follow.
• Company constitution. Your constitution may contain provisions about share transfers, director removal, and decision-making that supplement or override the replaceable rules in the Corporations Act 2001 (Cth).
• Founders agreement. If you signed an early-stage founders agreement before formalising your shareholders agreement, check whether it’s still in effect or was superseded. Contradictions between documents create uncertainty.
• Employment or service agreements. If the departing founder is an employee or contractor of the company, their employment or services agreement will govern notice periods, entitlements, and post-employment obligations like restraints of trade and confidentiality.

If you don’t have a shareholders agreement — and a surprising number of early-stage startups don’t — you’ll be relying on the replaceable rules in the Corporations Act and whatever your constitution says. This makes the departure significantly harder to manage cleanly.

Step 2: Determine What Kind of Leaver They Are

Most shareholders agreements distinguish between “good leavers” and “bad leavers.” The classification determines what happens to the departing founder’s shares.

Good leaver events are generally circumstances outside the founder’s control or departures that don’t harm the company. Common examples include:

• Resignation after a minimum period (often 12–24 months).
• Redundancy or role elimination.
• Death, permanent disability, or serious illness.

Bad leaver events involve fault or conduct that harms the company:

• Termination for cause (fraud, dishonesty, material breach of duties).
• Breach of the shareholders agreement or a restraint of trade.
• Voluntary resignation before the cliff period in a vesting schedule.
• Competing with the company while still a shareholder.

Why the distinction matters: a good leaver typically gets fair market value for their vested shares, while a bad leaver may be required to sell at a discount — sometimes at the original subscription price or even nominal value. The shareholders agreement should define both categories clearly and specify the pricing mechanism for each.

If your shareholders agreement doesn’t include leaver provisions, you have a problem. There’s no statutory default that forces a departing shareholder to sell their shares in a private company. They can simply remain on the register, retaining their equity and their rights, indefinitely. This is the “free rider” problem, and it’s one of the strongest arguments for putting a shareholders agreement in place before you need it.

Step 3: Deal With the Shares

Once you’ve classified the departure, the next question is what happens to the founder’s equity. This typically involves some combination of the following mechanisms.

Vesting and Unvested Shares

If the founders’ shares were subject to a vesting schedule — and they should have been — some portion of the departing founder’s shares may be unvested at the time of departure. The standard approach is:

• Unvested shares are bought back by the company or transferred to the remaining founders, usually at the original issue price (often nominal).
• Vested shares are treated according to the leaver provisions described above.

A typical vesting schedule runs for four years with a 12-month cliff. If a founder leaves before the cliff, they forfeit all their shares. After the cliff, shares vest monthly or quarterly. This structure protects the company from a founder who contributes for a few months and then walks away with a significant equity stake.

The mechanics of the buy-back itself also matter. Under the Corporations Act, a company buying back its own shares must comply with the requirements in Part 2J.1 — including solvency tests and, depending on the type of buy-back, shareholder approval and ASIC lodgement. For most founder departures, an “employee share scheme buy-back” or a “minimum holding buy-back” won’t apply, so you’ll likely be looking at a selective buy-back (requiring a special resolution) or an equal access scheme. Alternatively, the shareholders agreement may require the departing founder to transfer their unvested shares to the remaining founders rather than back to the company, which avoids the buy-back regime entirely.

Pre-Emptive Rights

If the departing founder is retaining vested shares and later wants to sell them, pre-emptive rights give the remaining shareholders the first right to purchase those shares before they can be offered to a third party. This keeps equity within the founding team and prevents unwanted third parties from appearing on your cap table — something investors will scrutinise carefully.

Compulsory Transfer

Some shareholders agreements include compulsory transfer provisions that require a departing founder to sell all their shares (vested and unvested) on departure, with the price determined by the leaver classification. This is the cleanest outcome for the company but can be contentious, particularly if the departing founder considers the valuation unfair.

Step 4: Resolve IP and Confidentiality

A founder departure creates a specific risk around intellectual property. If the departing founder contributed to the company’s core technology, product design, or branding, you need to confirm that the company — not the individual — owns that IP.

This should already be addressed by an IP assignment deed executed when the company was formed. If it wasn’t, this is the time to fix it. The departing founder should execute a confirmatory IP assignment as part of the exit documentation, assigning any IP they created during their involvement with the company.

The departure documents should also address:

• Confidentiality. Ongoing obligations not to use or disclose the company’s confidential information. These obligations should survive the departure indefinitely (or for a defined period — five years is common).
• Non-compete and non-solicitation. If the shareholders agreement or employment agreement includes restraint of trade provisions, confirm their scope and duration. Under Australian law, restraints are only enforceable to the extent they go no further than is reasonably necessary to protect the company’s legitimate business interests. Overly broad restraints — in geography, duration, or scope of restricted activity — will be struck down.
• Return of property. Laptops, access credentials, code repositories, cloud accounts, API keys, and any other company property or systems access must be returned or revoked.

Step 5: Remove Them as a Director

If the departing founder is a director of the company, their directorship needs to be formally terminated. The process depends on whether the departure is voluntary.

If the founder resigns as a director, the company should obtain a written resignation letter and update its records with ASIC (lodging a Form 484 — Change to Company Details — within 28 days). Under section 203A of the Corporations Act, a director of a proprietary company may resign by giving written notice to the company, subject to any restrictions in the company’s constitution.

If the founder refuses to resign, removal becomes more complex. For proprietary companies, the process is governed by the company’s constitution or shareholders agreement. If neither addresses removal, the replaceable rule in section 203C of the Corporations Act allows the other directors to remove a director by resolution. For public companies, section 203D requires a resolution of members.

Once the directorship ends, revoke all signing authorities, bank account access, and powers of attorney. Update ASIC records promptly. A former director who retains the ability to act on behalf of the company creates serious liability risks.

Step 6: Document Everything

The final step is to document the departure comprehensively. The key document is a Deed of Release and Settlement, which should cover:

• Confirmation of the share transfer or buy-back, including the price and payment terms.
• A mutual release of claims — both the company releasing claims against the departing founder and the departing founder releasing claims against the company and remaining founders.
• Confirmation that the departing founder has complied with (and will continue to comply with) their confidentiality, restraint, and IP obligations.
• Any transitional arrangements — handover of responsibilities, continued involvement for a defined period, advisory arrangements.
• Warranties from the departing founder that they haven’t done anything that would constitute a bad leaver event that hasn’t been disclosed.

Get the deed signed before any shares are transferred or payments are made. Once the equity has changed hands, you lose your leverage to negotiate outstanding issues.

Practical Advice: Do This Before You Need It

The best time to deal with a co-founder departure is before it happens. That means putting the following in place early:

1. A shareholders agreement with clear leaver provisions, vesting schedules, and a defined process for share transfers on departure.
2. IP assignment deeds executed by every founder at incorporation.
3. Employment or service agreements for every founder who works in the business, with appropriate restraint clauses.
4. A company constitution that’s consistent with your shareholders agreement and reflects your actual governance arrangements.

The cost of getting these documents right at the start is a fraction of the cost of resolving a disputed founder departure without them. If you’re navigating a co-founder departure — or want to make sure your startup is structured to handle one — get in touch. We work with founders at every stage to get these structures right.