What Every Startup Should Include in a Founders' Agreement
Starting a business with one or more co-founders often begins with a shared idea and an informal understanding of how everyone will contribute. As the business develops, however, expectations about ownership, responsibilities, decision-making, and the future of the company can become more complicated.
A Founders' Agreement can help establish clear expectations between the people starting a business and provide a framework for addressing important issues as the company grows.
Depending on the company's structure and jurisdiction, a Founders' Agreement may work alongside other corporate documents, including shareholder agreements, operating agreements, bylaws, and equity documents.
Addressing these matters early can help founders reduce uncertainty and establish a clearer legal framework for the business.
Why a Founders' Agreement Matters
Founders may initially agree on how the business will operate without formally documenting every detail. This may become more difficult when circumstances change.
Questions can arise about:
how ownership is divided;
who will be responsible for different areas of the business;
how important decisions will be made;
what happens if a founder leaves;
who owns intellectual property; and
how disagreements between founders will be resolved.
A written agreement can help founders address these questions before they become disputes.
Ownership and Equity
One of the most important issues for founders to address is ownership.
The agreement may identify each founder's ownership interest and explain the basis for that allocation. It may also address restrictions on transferring ownership interests and how future changes in the company's equity could affect the founders.
Some startups also use vesting arrangements for founder equity. Under a vesting arrangement, a founder's ownership interest may become fully earned over a specified period rather than being treated as fully vested from the beginning. Vesting can also address what happens to unvested interests if a founder leaves the business.
The appropriate structure will depend on the company's legal structure, jurisdiction, tax considerations, and the circumstances of the founding team.
Roles and Responsibilities
Founders may have different areas of responsibility within a startup. One founder may focus on product development while another manages sales, finance, or operations.
A Founders' Agreement can help document those expectations and may address:
each founder's role;
expected responsibilities;
time commitments;
management authority; and
how responsibilities may change as the company develops.
Clearly defining responsibilities can help reduce uncertainty and provide a basis for addressing changes as the business grows.
Decision-Making and Voting
Founders will not necessarily agree on every major business decision.
A Founders' Agreement can establish how important decisions will be made and whether certain matters require approval from multiple founders or a specified ownership threshold.
The decision-making structure should be consistent with the company's governing documents and applicable law. Different entity types and jurisdictions may have different rules regarding the authority of founders, directors, managers, and shareholders.
Depending on the business and its governing documents, major decisions may include:
issuing additional equity;
taking on significant debt;
selling substantial company assets;
entering into major transactions;
changing the company's business direction; and
selling or dissolving the company.
Intellectual Property Ownership
Intellectual property can be one of a startup's most important assets.
Founders may create software, designs, branding, written content, inventions, or other intellectual property before or after the company is formed.
A Founders' Agreement and related intellectual property documents can help address whether relevant intellectual property is owned personally by a founder or transferred to the company. The legal effect of any transfer will depend on the applicable law and the terms and execution of the relevant documents.
For example, under U.S. copyright law, copyright generally initially belongs to the author, subject to specific statutory rules such as the work-made-for-hire provisions. A transfer of copyright ownership generally must be documented in writing and signed by the owner or the owner's authorized agent.
These rules illustrate why founders should not assume that intellectual property automatically belongs to the company simply because it was created for the startup.
Confidentiality and Proprietary Information
Founders often have access to confidential business information, including customer information, financial records, product plans, technical information, and business strategies.
Confidentiality provisions can establish expectations regarding how this information should be handled during and after a founder's involvement with the business.
Depending on the circumstances, separate confidentiality agreements or Non-Disclosure Agreements (NDAs) may also be appropriate.
What Happens If a Founder Leaves?
A founder may leave a startup for many reasons. They may pursue another opportunity, become unable to continue working with the company, or have a disagreement with the other founders.
A Founders' Agreement can establish what happens to a founder's ownership interest when that occurs.
Depending on the circumstances, the agreement may address:
unvested equity;
restrictions on transferring shares or other ownership interests;
rights to purchase a departing founder's interest;
voluntary departures;
circumstances leading to a founder's departure; and
procedures for transferring ownership.
Addressing these issues in advance can help founders avoid having to negotiate fundamental ownership questions during a difficult transition.
Resolving Founder Disputes
Disagreements between founders can arise even when everyone initially shares the same goals.
A Founders' Agreement may establish a process for addressing disputes before they escalate. Depending on the circumstances, this could include negotiation, mediation, arbitration, or litigation.
The appropriate approach will depend on the company's structure, the agreement, and the laws governing the relationship.
Future Investment and Dilution
Many startups eventually seek outside investment.
When a company issues new equity to investors, the ownership percentages of existing founders may be affected. Founders should understand how future financing could affect their ownership interests and voting rights.
A Founders' Agreement may establish certain expectations regarding future equity issuances, but these arrangements should be considered alongside the company's governing documents and future investment agreements.
As a startup raises capital and its ownership structure develops, its legal documents may also need to be reviewed and updated.
Founder Contributions and Commitments
Founders do not always contribute to a business in the same way. One founder may contribute capital, while another contributes technical expertise, industry knowledge, intellectual property, or significant time.
A Founders' Agreement can document the contributions and commitments expected from each founder.
This can help clarify what each person is bringing to the business and provide a reference point if circumstances change.
What Founders Should Consider Before Signing
Before entering into a Founders' Agreement, founders may wish to consider:
how ownership will be divided;
what each founder will contribute;
each founder's role and responsibilities;
how important decisions will be made;
how intellectual property will be owned and transferred;
how confidential information will be protected;
what happens if a founder leaves;
how founder disputes will be addressed; and
how future investment may affect ownership and control.
These issues may seem straightforward when a business is first established, but they can become more complicated as the startup grows.
Conclusion
A startup's early stages often involve close collaboration between founders and a high level of trust. Informal understandings, however, may become difficult to manage as the business develops.
A carefully structured Founders' Agreement can help establish expectations regarding ownership, contributions, responsibilities, decision-making, intellectual property, founder departures, and dispute resolution.
The appropriate terms will depend on the company's structure, the relationship between the founders, and the laws that apply. Addressing these matters early can help founders establish a clearer legal framework as they build and grow the business.