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- If you have created your startup with more than one founder, then a founders’ agreement is essential for protecting your business—now and in the future.
- A founders’ agreement is a written, legally binding contract outlining the relationships between the founders. This agreement describes the roles, rights, and responsibilities of each founder. Additionally, the agreement addresses each founder’s assigned ownership (or equity) and how each founders’ equity will be distributed. The founders’ agreement also addresses the startup’s goals as well as its business and financial projections.
- The purpose of the founders’ agreement is to identify any potential misunderstandings in the founders’ business relationships while identifying potential risks. By detailing processes, procedures, and solutions to potential issues arising down the road, the founders can create a roadmap to prevent — or mitigate — future conflict.
- Before drafting your founders’ agreement, you’ll need to make several decisions with your co-founders. These conversations aren’t always easy. But they are necessary. It’s best to have these discussions early in the life of your startup when everyone is excited about the new venture.
- Some topics you’ll need to discuss before incorporating these provisions into your agreement include the founders' rights, responsibilities, and ownership.
- The most prudent practice here would be to hire a qualified startup attorney to help you draft your founders’ agreement, walking you through all of the intricacies of the law in the process.
- You can also find legal templates online that you can customize to your startup's needs. These would serve as a solid foundation on which to base your founders' agreement.
- A founders’ agreement ultimately helps all co-founders align their interests and expectations while providing a blueprint for best practices when efficiently running and growing your startup.
As a startup founder, you’re running a mile a minute while keeping a thousand balls in the air. But, to protect your idea, your startup, and you as a founder, you need to take the time to make sure your business and legal documents are buttoned up.
One of these documents is the founders’ agreement. If you have created your startup with more than one founder, then this agreement is essential for protecting your business —now and in the future.
This article will address the elements of a founders’ agreement, how to implement it, and the reasons why this agreement is so critical to your startup’s success.
What is a Founders' Agreement?
A founders’ agreement is a written, legally binding contract outlining the relationships between the startup founders. This agreement describes the roles, rights, and responsibilities of each founder. Additionally, the agreement addresses each founder’s assigned ownership (or equity) and how each founder's equity will be distributed. The founders’ agreement also addresses the startup’s goals as well as its business and financial projections.
The purpose of this agreement is to identify any potential misunderstandings in the founders’ business relationships while identifying potential risks. By detailing processes, procedures, and solutions to potential issues arising down the road, the founders can create a roadmap to prevent — or mitigate — future conflict.
A founders’ agreement can be separately drafted, or its provisions can be included in other business formation documents, such as an LLC operating agreement. Like any legal document, it would be best to engage a qualified attorney to help with drafting the founders’ agreement, making sure you don’t miss critical issues.
What Should You Include in Your Founders’ Agreement?
Before drafting your founders’ agreement, you’ll need to make several decisions with your co-founders. These conversations aren’t always easy, but they are necessary. It’s best to have these discussions early in the life of your startup when everyone is excited about the new venture.
Here are some topics that you’ll need to discuss before incorporating these provisions into your agreement.
- Names of business and co-founders. Be sure to check the availability of your chosen startup name with your state’s secretary of state’s office before committing to a name that another active entity may have already taken. Most states have a name availability database, allowing you to quickly type your selected name into the field, seeing if it’s available. If it is available, you’ll want to reserve your startup’s name if you haven’t already secured it through your business formation documents.
- Business purpose. Describe the purpose and goals of your startup in detail. For example, what products do you offer? Who is your target market? What is your competitive differentiator? What is your go-to-market strategy? Additionally, you may want to reduce projected milestones to writing as well, allowing you to track your startup’s progress.
- Ownership. Identify how much equity (or ownership) each founder has, as well as how and when that equity will vest. Keep in mind that co-ownership does not mean equal ownership. For example, the founder coming up with the initial idea may have more startup equity than a founder providing CFO services. Here, you also want to detail how and when the equity will be distributed. In addition, you want to determine how much equity to set aside for future hires and employees — which typically falls in the 10 percent range.
- Confidentiality. This is an excellent time to address confidentiality agreements among co-founders. Let’s face it; you don’t want a co-founder potentially talking about your startup’s processes, procedures, intellectual property, and other protected information to anyone outside of your circle. By implementing confidentiality agreements, you can add another layer of protection for your startup.
- The roles, rights, and responsibilities of each founder. Detail each co-founder’s roles, rights, and responsibilities, as this is often an area of miscommunication or unrealistic expectations. Not every decision needs to be made by all co-founders. By delineating duties among the team, you’ll be able to run faster and more efficiently instead of getting bogged down in group meetings and decision-making. Also, by making sure each founder knows what is expected of them, you allow your startup to run without confusion or duplication of effort.
- Founders’ compensation. In addition to the roles, rights, and responsibilities, you’ll need to address each founder’s compensation and benefits, so there are no misunderstandings. You don’t want founders complaining down the road that they are not getting paid enough for their services. By agreeing to this upfront, you avoid those sticky conversations.
- Intellectual property. As a startup, and especially a tech startup, you want to designate and protect the intellectual property (IP) belonging to the company. If any founders have created IP that is eventually used in the startup, be sure to address the assignment of that IP from the individual founder to the company itself. Since IP is one of your startup’s most valuable assets, detailing what it is considered IP and how it is owned is critical — not only to you and your co-founders but also to potential investors.
- Conflict resolution. No matter how well you plan, conflicts will arise. Include processes and procedures for resolving disputes and other future issues by including provisions for mediation or arbitration.
- Amendment procedures. Include procedures for amending your founders’ agreement as well, allowing it to evolve. Because things change, and they typically change fast with a startup, you want to have the option to amend the agreement. However, you don’t want to depend too heavily on this option, meaning you don’t want to have to go back and amend your founders’ agreement multiple times. Ensure that you have an initial solid agreement addressing as many potential issues raised by you, your co-founders, and your startup lawyer that you can think of creating a comprehensive document. This is not the time to develop a half-done contract thinking you’ll put more time into it down the road. The founders’ agreement is too important.
- Termination and exits. Finally, in your founders’ agreement, you’ll need to detail the terms of the agreement and how to terminate it. You should address what happens if and when founders leave the startup — both voluntarily and involuntarily. For example, the founders may decide to vote another founder out of business. How does this happen procedurally? What happens to that founders’ shares? Are they forfeited?
Addressing these issues is never fun. However, addressing them early in the process, when everyone is excited about the startup’s potential and progress, is the best time. You don’t want to wait to have these discussions when a serious problem stares you in the face.
What is the Process for a Co-Founder Agreement?
Now that you and your co-founders have worked through the above issues — ideally with an attorney — it’s time to draft the agreement. Luckily, you have plenty of options to do so.
The most prudent practice here would be to hire a qualified startup attorney to help you draft your founders’ agreement, walking you through all of the intricacies of the law in the process. If you don’t want to work with an attorney initially, you can also access legal resources that walk you through the drafting process with questionnaires and providing you model language templates along the way. These resources can help you customize the founders’ agreement to your startup's requirements.
Once the agreement is drafted, have all founders carefully review the document, ensuring it addresses all critical issues. If you did not use an attorney to draft the initial contract but instead utilized templates to do so, now would be a good time to let a startup attorney review your draft, ensuring that all legal issues have been addressed. An attorney can spot common problems that may arise down the road while making sure that your contract holds up in court.
Expect revisions to the founders’ agreement as you iron out the language and the details. However, once the document is finalized, then allow all founders to have their personal attorneys review the agreement. Once they are all comfortable with the contract, it’s time to sign and date it, legally finalizing it. Be sure to store the paper or electronic version of the final agreement in a safe place.
And, although filing it away in a safe place is prudent, make sure you use this document when running your business. Don’t let it gather dust.
What is the Importance of a Founders’ Agreement?
Although a founders’ agreement is not required by law, you can see from above how important it is to the ultimate success of your startup. Think of it as your insurance against future misunderstandings and problems. If something pops up down the road, you have a well-drafted founders’ agreement guiding you through resolution.
The benefits of creating a founders’ agreement include:
- Allowing you to have open and frank discussions with your co-founders about your startup
- Clarifying each founder's role in the startup
- Providing guidance on how to resolve issues
- Protecting founders
- Safeguarding confidential information
- Showing potential investors that you have a serious, organized business
A founders’ agreement ultimately helps all co-founders align their interests and expectations while providing a blueprint for best practices when efficiently running and growing your startup. Make sure you devote time to creating this agreement for the betterment of your startup.
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