Forming a competing company to take 100% ownership of the business you built

The bold response when your employer reneges on promise of shared ownership.

There are times when the owner or owners of a company need specific knowledge or capabilities to retain or develop new business or exploit a perceived opportunity, and thus willingly offer equity and shared ownership in order to recruit the necessary executive talent. If you had taken a C-level executive job offer, in those circumstances, relying on such a promise, and you then put in the effort, contributed what you could and succeeded in building up that business, you reasonably expect the owners to live up to their side of the bargain.  Sadly, all too often, the owners renege.

When the owners have benefited and failed to live up to their word, essentially cheating you out of the equity you earned… what can you do? 

At this point, your right response might be the bold one.  Cease the begging.  No more efforts to try to “guilt” the owners into doing the right thing.  Just give up on the quest to obtain partial ownership, but instead go in a different direction.  Instead of asking again, form a competing company, take 100% ownership, and beat the pants off those ungrateful owners in direct head-to-head competition.

This bold course of action is not without risks. But for a number of my clients, where the circumstances were right, they accepted my advice, and they did indeed achieve their equity goal and even more and it came at a cost to the company that did them wrong.  This article explores this bold strategy through the following topics – 

• What are the right circumstances to take the ownership you were promised?
• What are the constraints and circumstances that would limit such action?
• How do you go about setting up shop in competition?  
• Is this the right choice for you?

What are right circumstances to go on your own

The best circumstances are when you control production, marketing and sales.  

In one circumstance, my client had brought the company 400% growth over the course of four years.  In that process, my client had recruited all the staff.  The staff knew him and liked him and had little direct contact with the owner. Similarly, my client had developed the new product lines, and marketing campaigns.  Finally, he was the one who had developed the relationships of trust with almost all the main customers.

My client had been promised 50% ownership, but after four years the owner had never come through with the paper work and finally after four years, the owner indicated more time was needed and that they would need to work out how my client could buy his share. 

My client was in a position to walk out and take 90% of the employees and 85% of the customers and pay nothing to the owner. He did so.  Within two years, by the time he had the capacity built up, all of the key employees he had wanted had migrated and he now had more than 80% of the clients too.  Within 5 years, his prior company was out of business.

Those circumstances and results have occurred for other clients I have represented in varied industries.  But the fact patterns are similar.  My client had the knowledge and smarts and put in the effort and essentially through his or her efforts had come to own the means of production in all but official title.  In each case, when his or her equity was not honored, each left and within a few years, the business had migrated to their new company which they owned 100%.

Constraints and limitations  to your action 

The biggest limit would be the mobility of the business.  Can the staff and client move with you? Are there working terms and conditions that prevent movement?  Are there long-term contracts or other constraints on movement by the clients?  Are there products unique to the business that you cannot take with you?  Will you be able to work with any needed suppliers?

The second biggest is cost for set-up and financing that new company. Here it is best to focus small on the most important employees and ones likely to go with you, and customers you are confident you can take.  You want to take space and capacity geared toward a modest opening with sure things.  When more business comes, you can later expand.  Hopefully, with a modest office footprint, you did not overextend your resources, including your ability to borrow, use savings and tap friends and family.

The other major constraint, every bit as important as the first two – contractual and intellectual property constraints.  If you have signed a noncompete agreement, a non-solicitation agreement and/or an assignment of inventions / trade secret agreement, this clearly can be a constraint. However, even all three are not necessarily dispositive of whether you can go on your own.  

For existing restrictive covenants, clearly, you need review and guidance by your attorney.  However, for the non-compete, it might potentially be unenforceable or there may be other work-arounds.  The non-solicitation agreement might be more likely to be enforced, however, work-arounds here may well be possible.  With you gone, your prior employer may be in no position to hold the business and with urging of the customer, may accept waiver of the non-solicitation in exchange for a small percentage of your first-year profits. 

Do’s and Don’ts of setting up shop in competition

Beware that while you are still under employ, you must continue to perform your duties in the best interests of your employer.  That is called the duty of loyalty. You must not solicit any customers, or get other employees involved in your new company before you have resigned from your current employment.  While employed at your current company, you likely have access to confidential information such as lists and details of clients and leads, terms of business, pricing strategies, marketing plans, forecasts etc.  Use extra caution or seek legal advice if you intend to use any of this information in setting up or operating your new business

Perhaps you have been the key person who built the business at your current employer.  There may be a person you invite as a partner or co-founder of your new business.  You can share plans with a co-founder but he or she, too, owes the duty of loyalty to the company.

However, you may still make preparations to setup a new business such as determining the name of your business, something different from the current employer but also something catchy, suggestive of your product or service, that might attract business.  You can file an intent to use (ITU) trademark, form a corporation or LLC, write a business plan, secure financing, find vendors, and sign a lease.  None of these things causes harm to your current employer, but each of these will have you in a position to hit the ground running when you launch.

Once you, including your partner, if any, have resigned and fully separated from the company, you can now fully launch.  By this point all prior contracts should have been reviewed with counsel.  Once you are out, then to the extent counsel clears you, you can then solicit key employees and clients.  These steps can all be worked out in advance.  The important thing is to take no action until you are safely clear of your former company, so that you did not use any company facilities, offices or staff against its interests.

Is this the right choice for you?

Not everyone is cut out to be the CEO, or to be the George Washington in rebellion against the old ogre company and owners.  For many, making the jump from a C-level officer leading your department to being CEO leading the business is almost a natural step in your career progress.  But for others it is a step too far. 

One caution.  If you feel this is the right move for you but you just don’t feel right being CEO, then you might choose to bring in another person or anoint a partner to be CEO.  My caution and suggestion is Ronald Reaganesque – Trust but verify.   Since it is you and perhaps one or two partners who control the production, marketing and sales that makes the business viable but feel the need to bring in a leader, put that leader on an employment at will contract that enables termination if you and your board are not satisfied with his or her performance and put his or her stock on a 4-year vesting schedule, so that if he or she is terminated within a year or two, you get most of your equity back.  Unfortunately, all too many who fail to heed this caution find themselves saddled with an underperforming CEO, or just as bad, a departed CEO who holds a significant block of stock they cannot get back.

My final word of advice here:   It can be lonely at the top.  This is especially so for a first time CEO.  But there are remedies for this malady also:  networking.  Look for CEO peer groups, both in your region but also remotely via Zoom.  This can give you a place to let your hair down, share issues you are facing, get advice and offer it. 

If you have essentially built a business, with production, marketing and sales, and the owner has chosen not to fulfill his or her promises to you of shared ownership, this article suggests to you a road map for self-help.  With the right executive employment counsel advising you, you may well be able to take charge.  For many who have done just that, it has proven to be professionally and financially rewarding.  Whichever course you take, best of luck to you! 

Written by Robert A. Adelson, Esq.
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