Why you need to get a founders’ agreement in place for your startup
Got yourself a great business idea?
Let me start with the bad news first. It's going to be a very bumpy ride; only 10 percent of the business survives the first five years. Competition is rarely the reason for a startup failure; their infant death is attributed to weak management, indecisiveness, and mistrust amongst the founders.
Startups are not meant to be one-person rides. You need people by your side. Someone whom you can trust for skills, commitment, and persistence. A good startup team would consist of more than one founder with complementing skill-sets and domain expertise.
Before rushing to getting your product off the ground, you need to lay a solid foundation. It includes thinking through the problems you face, events of changing expectations, possible conflicts, etc.
It's okay to start with a mutual understanding but it is advisable to document it in the form of a ‘founder agreement’ as soon as possible.
What is a founders’ agreement?
A founder’s agreement is a legal contract between the founders that defines roles, responsibility, shares of equity, exit options, etc. It is designed to protect each member's interests and to prevent future conflicts. A founders’ agreement helps you by
- Defining the role and expectations from each founding members
- Defining a structure to resolve potential conflicts
- Defining a process of exit or adding new members
- Protecting minority stakeholders
- Paving ways for future investment and growth
Basic elements of a founders’ agreement
Personal details -
This includes details of the founders, their roles, and responsibilities. Other details include the name of the company and registered office.
Equity breakdown -
Equity is the most expensive asset for a company. The equal division is not a mandate but it should be in proportion to what the other person is bringing to the table - domain expertise, money, efforts, resources, etc.
Decision-making powers -
A few tough decisions are the mandate for running a startup. How do you plan to take such hard calls? Is it better to have one person with the power to decide? How do you check and balance? It's a tough call between one person having unchecked power as against having a decision paralysis at a crucial time. Decisions would range from bringing investments, vesting equities, adding new people to the core team, termination and pivoting, etc. You can have a clear division of areas and ownership for business development, marketing, product development, etc. The person who is owning a domain can have more power in that area, but a clear decision-making structure should be defined as critical decisions related to future growth and hard times.
The vesting schedule is equally crucial. What if one of the founders becomes lenient after getting the equity. What if one of you wants to leave after a year or two? Does the leaving member keep his/her shares or have to surrender? In the event of a surrender, how do the remaining members distribute those shares? What if you have to add a new member to the team? The founder’s agreement should clearly define the vesting schedule to avoid future conflicts. This becomes even more critical when you raise funding from outside. You should also have a documented understanding of how and under what conditions these agreed-upon vesting terms can be modified.
If you are working in a high-tech domain, it's possible that one of the founders had a major role in developing that product. He/she has all the right to be attached to their innovation, but any IPR should be owned by the company and not by an individual. The innovator can be rewarded with higher equity if required but once you form an entity, everything is owned by the entity and not by an individual. This helps you protect the organisation when an individual decides to break away. He/she should not claim a right over the product or develop a similar prototype with someone else.
Confidentiality and non-compete clause
As a founder, you are expected to have access to confidential information. The core team should trust each other. What if one of the founders decides to leave and share the critical confidential information with one of your competitors? Your agreement should have a binding time for any parting member. The parting members should not join competition, start a similar business, break away suppliers, vendors, employees, or clients.
Remuneration and compensation
How do you plan to compensate each other for the time and effort? How do you define the remuneration? Is it based on needs or contribution?
Disputes and resolution
Conflicts, disputes, and disagreements are a part of startup life. Maturity lies in thinking ahead through the scenario, and agreeing and documenting a framework/process to resolve such a conflict.
Exit and winding up
One of you might have to leave for some unforeseen reasons. The exit clause should also cover the process of handling underperforming members. What if you need to wind up? How do you share the liabilities, profits or assets?
How to get started
By now you have a clear understanding of what entails a founders’ agreement and its importance.
Once you have filled in the basic details, it is time for some hard talk between the founding members. Discuss and iron out a few things like equity, vesting schedule, roles and responsibilities, winding and exit clauses, etc. You can have a series of meetings to come up with agreeable terms. The outcome of such a process should be all founders agreeing on the minutest details. It’s not advised to leave even the smallest difference of opinion for a later discussion.
Once you have detailed out the basic agreement between founders. You may opt for the services of a competent startup lawyer who can give you a legal form to your understanding.
If there are some differences that you are unable to sort out, you can involve someone whom you mutually trust. They can be your professor, mentor, or any professional expert hired for such advice. If possible, get a fellow entrepreneur who has already been through such an experience to offer some insights.
Once the agreement is finalised, each founder should get a registered copy of the agreement for their future reference.
No agreement can define your mutual trust and respect for each other. Startups are tough bumpy rides and there would be a lot of hiccups. In case you are unable to trust each other at this moment, this is the right time to part ways. But once you commit to something, it’s your obligation to give 100 percent, not just for the interest of each other, but for all stakeholders who trusted your vision.
(Edited by Evelyn Ratnakumar)
(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)