While the founders of a business may all start off on the same page, things very often don’t stay that way. In the event of complications arising between startup founders, a Founders’ Agreement could prove invaluable.
In today’s startup generation, documenting the arrangement between the founders of a business is often the lowest priority for an entrepreneur. When a group of individuals, be it friends or family, come together to form a new business, they would typically have a shared understanding of what the nature of the business will be, what their common vision for the business is, who will bring in the initial capital, who will provide office space, computers and other infrastructure, and what the roles of each founder will be. The initial focus of most entrepreneurs is understandably fixed on their business opportunity, and unfortunately, the critical need to document the founders’ initial understanding is often overlooked.
Over time, as the business succeeds or faces market pressures, the need for an agreement between the founders begins to be felt. As other stakeholders join the business, such as external investors, lenders, and key employees, the initial business understanding between the founders is sometimes superseded and even forgotten. As the business grows, the initial business objectives may appear less appealing, and new attractive opportunities may emerge. Certain founders may contribute less than their expected share of funding or workload, and other founders may carry a greater load. The sharing of rewards from the business may not be proportionate to the founders’ respective contributions to its growth. The business could also face continuity risks due to certain founders disassociating from the business.
It is in this context that Founders’ Agreements have emerged as a necessity for every new business. Early-stage investors commonly insist that a startup have a Founders’ Agreement in place, as a prerequisite for evaluating the investment opportunity, since this provides an investor with a crystallised picture of the structure of the business and the roles, responsibilities, and rights of its founders.
In essence, a Founders’ Agreement sets out in writing the agreement between the founders of a business. It contains the basic principles of the business to be established. Every Founders’ Agreement would typically cover the following:
- Description of the business: It should describe the business opportunity to be pursued, and could include an initial business plan.
- Roles and responsibilities of the founders: It should describe the roles and responsibilities of each of the founders, their job designation, and remuneration. A non-compete obligation could also be imposed on the founders.
- Initial funding: This explains who will bring in the initial funding and how future funds will be raised. If loans are to be availed of, it explains who will provide personal guarantees or security to the lenders.
- Shareholding pattern and first Board of Directors: To clarify the ownership (shareholding) and the management (directors) of the business.
- Share transfer restrictions and procedures: Typically, the founders could be restricted from selling their shares for an initial lock-in period. After the lock-in period, a right of first refusal could be made applicable to ensure that founders do not sell their shares to outsiders.
- Severance options: The agreement should describe what happens if a founder disassociates with the business. Typically, the continuing founders should have the ability to purchase the exiting founder’s shares.
- Deadlock resolution and arbitration: The agreement should provide for a mechanism to redress disputes and disagreements between the founders quickly and efficiently.
A Founders’ Agreement may also aim at ensuring that the founders vote as a single block against any external shareholders, which helps to ensure that the majority control of a business remains with its founders. Experience shows that infighting and division between the founders or promoters of a business poses just as much risk, if not more, to a business as a faulty business model. A Founders’ Agreement attempts to minimise founder disagreements by clearly setting out the rights and roles of the founders, and provides a platform for amicably redressing any founder disagreements.
Like an infant requires care and nurturing to thrive, a startup similarly requires such attention in order to succeed. Founders’ Agreements are widely viewed as essential to every startup business since they provide a definite framework within which the founders agree to work together towards their common goals.
(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)
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