A Founders’ Agreement is a contract that a company’s founders enter into that governs their business relationships. The Agreement lays out the rights, responsibilities, liabilities, and obligations of each founder. Generally speaking, it regulates matters that may not be covered by the company’s operating agreement.
Ultimately, Founders’ Agreements are designed to protect each founder’s
interests and memorialize that all founders are in agreement about the
venture’s basic structure and how the founders will work together to
move their business forward. Forging an agreement between all founders
helps mitigate the risk of a lawsuit over who owns the business.
There is a wide range of provisions that could be addressed in a Founders’
Agreement.A founders’ agreement is a baseline for how your co-founder relationships will work in the future, how your company is structured, and what each owner brings to the business. It’s important no matter what type of business entity structure you have.
Drawing up a founders’ agreement is best done as soon as that sparkle in your eye becomes an actual business plan: when things progress from “I have this idea” to “Let’s actually do this,” you’ll want one to be drawn up. And if you’ve passed that stage already—better late than never. You can’t predict the future, but you can control the present.
Here are some of the reasons why having a founders’ agreement is essential:
Clarifies each owner’s role in the business
Provides a structure for resolving disputes among founders
Provides clarity if and when a partner wants to enter or exit the business
Protects minority owners
Signals to investors that you have a serious business
Lawyers and entrepreneurs understand that a founders’ agreement is an initial assessment of how things stand when the business is young. If circumstances shift slightly later on, it’s not that big of a deal. You can include procedures in this document for making necessary changes and updates. But it’s the ideal place for you and your co-founders to think through any potential problems you or your business might face—and to brainstorm solutions for the future.
What to Include in Your Founders’ Agreement
transfer of ownership;
decision-making and dispute resolution;
representations and warranties; and
choice of law.
These are essential provisions that are commonly seen in Founders’
Each Owner’s Roles and Responsibilities
Even if you run a tight ship of a small business, not every decision should be up to every co-founder… As much as it might feel like the opposite, especially if you’ve only just started your company.
The fact of the matter is that divvying up roles and delineating responsibilities early on lets you avoid confusion and redundancy. Two co-founders might both want to tackle every part of their business, but a CEO and a CTO? Not so much. Making sure everyone knows what they need to be doing means that you’ll have a less wasteful, more efficient business. The more specific you can get, the clearer it will be whether Bob is making unique contributions or reworking well-trodden ground. Cut costs and time sinks as much as possible, especially in your early days.
Of course, that doesn’t mean you need to abandon teamwork, transparency, and communication. In fact, by establishing distinct roles and responsibilities, you’re making it as easily understandable as possible who gets the final say on which things, and which other aspects of your business should be determined by consensus.
Finally, you’re creating a system of accountability—if something doesn’t get done, you know who the buck stops with. Likewise, if things do get done, you know who to congratulate. Accountability isn’t just a way to measure whether co-founders aren’t working hard enough: it goes both ways. You might even include rules for adjusting compensation, or equity, depending on performance.
The co-founders of a business will naturally want to share the business itself—that’s the basic idea behind equity. But how do you divide your company’s equity among its co-founders? Deciding in your founders’ agreement will help you dodge misunderstandings, hurt feelings, and potentially worse.
First of all, you’ll only want to split up about 80%-90% of your equity—it’s better to save at least 10% for future hires and other circumstances.
Second, you’ll just need to have a long and serious discussion about the method and distribution of your shares. There are plenty of ways to do it, but there’s no one right way—it depends on your partnership, your business, and your personalities and contributions.
For example, some co-founders might just want to split the equity evenly between themselves. Others might want to distribute them according to the roles and responsibilities (which we discussed earlier!), or according to who fronted the most cash to get the business on its feet. Maybe you’ll give a bigger percentage to the person who came up with the idea in the first place, or to the one who coded the first demo or made the first batch.
There’s no right or wrong answer. Just make sure that if two owners have equal equity and voting rights, you should include a tie breaking procedure of some kind so there isn’t an impasse on important company issues.
You’re probably starting to see just how useful a specific founders’ agreement can be by now, huh? By laying out all of these financial details as early as possible, you’ll prevent any serious emergencies that a disagreement down the line might cause.
We can’t talk about equity without talking about vesting: if co-founders got their shares all at once, there would be nothing stopping half of them from hitting the snooze button and letting you do the work. By creating a vesting schedule—often four years with monthly installments—you’re encouraging everyone to earn their keep. Plus, investors will expect a market-typical vesting schedule, and not having one wouldn’t be a great sign.
Treat this section of your agreement seriously: it can have substantial consequences for your business. Check out some templates online, and set aside time to have these talks with your co-founders.
Intellectual Property is the creative material that goes into setting your business apart from every other business. That includes your products, recipes, marketing materials, logo, branding, packaging, website, business plan, theme songs, inventions, and more. Needless to say, your intellectual property is important to protect—and the founders’ agreement is a great place to do just that.
First of all, you should make sure that any intellectual property developed for your business goes to the entity itself, not to any particular person. For example, say one of your co-founders comes up with a great new recipe or procedure. Your agreement should state that any intellectual property devised for the business, during work hours, is owned by the business and not by any co-founder or employee who came up with it.
Ideally this would never become a problem, but suppose someone decided to break away and form a successful competing business—all because of an invention they came up with while working with you. Protect yourself—and your intellectual property!
To start, you’ll need to decide what constitutes intellectual property for your company. Anything the co-founders create, relating to the company, during work hours—that’s an easy one. But what about a co-founder on vacation brainstorming new ideas? If something was written in the “notes” section of a company phone, is it the business’s intellectual property? You might feel inclined to be hard-nosed about this, but that’s not necessarily the best approach.
Third of all, you should outline the terms for selling off your intellectual property—which may or may not include the terms for selling off the entire company too. Who has the authority to make that kind of decision? Where does that revenue go? These are just a few questions you’ll want to answer ahead of time.
Finally, considering discussing non-compete clauses and confidentiality agreements, too. Should a co-founder be able to own stock in competing companies? Or consult for competitors? Hopefully, this is never a problem for your business. But the whole point of a founders’ agreement is to be prepared, so even if you trust your co-founders more than your own grandmother, don’t give them an easy out in case things change without you realizing!
Salary and Compensation
Again, the salary and compensation part of the founders’ agreement is pretty basic—but incredibly important. Noticing the trend? We tend to overlook discussing these fundamentals when the entrepreneurial gears are spinning, but writing up an agreement forces us to address these topics… And clear up any mismatched expectations everyone could be bringing to the table.
It’s up to you how in-depth you want to go. You can create a thorough compensation plan that accounts for future growth, or you could just deal with present circumstances. Either way, setting a baseline will help you avoid unpleasant surprises.
Plus, this isn’t a bad place to consider figuring out how co-founders can use company money (or not!), whether they can own stock in the competition (and how much, if so?), and who approves investments or debt (and what the processes are).
Finally, a founders’ agreement should go over the circumstances of exit: what happens when a co-founder has been consistently underperforming, and needs to be let go? What if a co-founder voluntarily wants to leave the company?
Remember that while all of these conversations might feel awkward to bring up, they protect every co-founder equally. No one is exempt. The issues dealt with by a founders’ agreement are unfortunately not uncommon, and every good partner will understand the need for this kind of preparation.
That said, termination clauses can definitely be the most stressful topic to make a decision on. What would you want to happen if your co-founder flunked out on you? What would you want to happen if you were underperforming and dragging the business down? Or, alternatively, what happens if someone just wants to leave—for whatever reason they might have?
You’ll want to figure out what happens with unvested shares, especially. Often a company will have the opportunity to purchase those shares back from the founder at their original price, but that procedure is in your hands, too. Just setting up a system to deal with termination will go a long way—especially if that termination isn’t a friendly one and attorneys are brought into the picture. If that’s the case, your agreement will show that everyone previously agreed on a precedent in writing. That’s a powerful defense in the eyes of the law.