If you are founding a startup, executing a founders' agreement is imperative. A founders' agreement spells out terms which govern business ownership and regulates the founder’s business relationship. This ensures that each founder's obligations, stake, and benefits, are not in doubt from day one. With this, avoidable issues or disagreements are avoided. All conflicts that may be foreseen or foreseeable are effectively addressed or checked. These help to significantly minimize business risks, thus setting up your startup for success early in the game. This is why a founders’ agreement is one of the things a startup badly needs.
What is a Founders' Agreement?
A founders' agreement is a contract that elucidates the rights, roles, responsibilities, and obligations of each founder. It is legally binding and aims to safeguard the interests of each founder while forestalling any possible conflict that may arise. Conflict amongst founders, whether potential or real, is one of the biggest threats to the success of a startup. This is one of the major reasons why it’s essential to have a founders’ agreement right from the outset or onset.
Why is it essential to have a Founders' Agreement?
There are four major reasons why startups badly need a founders agreement:
- Clarity: It states the roles and powers of each founder as well as other obligations.
- Protection: It offers legal protection to founders and also acts as a shield for minority owners.
- Perception: The existence of a founders' agreement gives investors and partners the idea of professionalism, thus boosts their confidence in the future of the startup.
- Structure: It provides a basis for structuring founders' relationship and resolving disputes through the use of essential clauses in the agreement.
Essential Clauses Contained in a Founders' Agreement
What startups badly need to ensure is that the essential clauses are included in their founders’ agreement otherwise the agreement could do more harm than good. Below are just 7 essential clauses:
- Names, Roles, and Responsibilities of the Founders: Assumptions or oral designation of roles and responsibilities have been and continues to be a major source of conflict amongst founders and co-founders. It is, therefore, necessary to clearly define each person's role and duty.
- Ownership and Powers: The number of shares or equity stake of each founder should be clearly stated in the agreement. It should also contain clauses on the powers exercisable by each person and any limitations which apply.
- Vesting Clause: By subjecting equity to a vesting clause, a startup is effectively ensuring that a founder or co-founder will provide good consideraion for the equity as expected. It also ensures that no founder unduly holds the startup down.
- Intellectual Property Ownership: At the commencement of a business, various co-founders create intellectual property (IP) for the business entity. It is imperative to ensure that such IP belongs to the startup itself and not the individuals behind its development, except the intentions of the founders are otherwise. This way, if an individual decides to leave the enterprise, the startup does not lose the IP.
- Remuneration and Compensation: This provision is basic yet vital in a founders' agreement. Each founder may have his or her expectation of the amount and mode of payment. To avoid any uncertainty or conflict, it is necessary to have a spelled-out plan for remuneration and compensation, considering any future changes which may occur.
- Exit Clause: From day one, a startup should envisage exit of founders from the business. The circumstances under which a founder may exit from the startup and be released from his or obligations should be mutually agreed upon.
- Dispute Resolution: It is essential to include the method to be adopted in resolving disputes as conflicts are usually inevitable in any business. The mode of dispute resolution could be Alternative Dispute Resolution (ADR), litigation, or any other means of dispute resolution. Because a dispute resolution clause done wrongly–and indeed any clause at all–could make or mar the startup, getting the drafts right is imperative.
How to create a Founders' Agreement
One of the things startups badly need to do which many fail to do until it’s often too late is have honest conversations. Assumptions are dangerous for a startup. So leave no stone unturned, otherwise one of the founders or co-founders would sooner or later caste the first stone.
In creating a Founders' Agreement, there are two steps founders or co-founders must take:
- Have a Sit-down: The first step to take in is for the founder to have a sit-down with other co-founders to discuss the intricacies of operating the business. Each founder's or co-founder’s compensation, equity, responsibility, role, and any other obligations or concern should be identified, discussed and specified.
- Consult a Startup Attorney: The next step is to consult a startup attorney. Drafting agreements and contracts should be left to the professionals who understand best the underlying legal principles and from experience have the business insight needed for preparing such documents. This will go a long way in significantly avoiding both business and legal risks (or at least minimizing unavoidable risks). Any mistakes or omission could be fatal, as it has proven for many startups.
Now you know why startups badly need a founders’ agreement. Act NOW.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.