Co-founders of a start-up venture often find themselves excited and enthusiastic about getting their business idea off the ground. Amidst the whirlwind of developing a product or service and forming a team, it can be easy for the founders of the start-up to put legal work on the backburner. That is often a costly mistake. This blog post is the first in a series of articles on legal issues facing early stage ventures. In this installment, we will discuss founders' agreements.
What is a Founders' Agreement?
A founders' agreement is a contract between a company's founders that outlines the founders' rights and responsibilities, as well as the founders' obligations to one another with respect to the business. A well drafted founders' agreement is a product of conversations between the founders and their attorney that force the founders to consider how they will work together to make the company a success. It is important for the founders to have this conversation early on in the life of their start-up venture, so that the founders can agree upon: (1) the basic terms of the founders' relationship; and (2) how the founders will resolve any future conflict between founders, before any disputes arise. With an effective founders' agreement, the founders will have an agreed upon policy to turn to when conflict arises between founders.
What is in a Founders' Agreement?
A founders' agreement should cover the basic issues that could arise and cause a dispute between the founders. These issues include:
- Transfer of ownership – If one founder would like to leave the venture and sell their equity, what restrictions will apply? Must the founder offer his or her co-founders the opportunity to purchase his or her equity?
- Equity and Vesting – How much of the company will each co-founder own? Will the equity percentage held by each co-founder change over time? How long must the co-founder remain with the company for his or her equity to vest?
- Decision-making power and processes – Which founder or founders will make the day-to-day decisions of the company? Who will make the major decisions of the company? What processes will be used to ratify these decisions?
- Commitment expectations – What role will each founder play in the company? What are each co-founder's specific responsibilities? Is a certain time or effort commitment expected of each co-founder? What happens if a co-founder does not meet the expectations set forth in the founders' agreement?
- Capital Contributions – Will each co-founder be required to contribute capital to the venture? When will this contribution, or these contributions, be required? Will the capital contributions have an effect on equity?
- Compensation – Will the co-founders receive a salary? What will the salary be? What types of deferred compensation will be made available to the co-founders, and who will receive each type of deferred compensation?
- Confidentiality – What standard of confidentiality do the co-founders agree upon with respect to the business? When does this standard apply?
When should co-founders start thinking about a founders' agreement?
It is never too early to begin thinking about a founders' agreement.