How to create a solid Founders’ Agreement
By AL Walker, Last updated: 2021-08-12 (originally published on 2021-05-31)
When starting a business —whether you plan for it to be a big one or a small one— if you are doing it with other people, you’re going to want to begin with a Founders’ Agreement. There are several reasons this is important. They extend from reducing risk to establishing the protocol for how the business will be run. Let’s be clear, if you don’t have a Founders’ Agreement to guide decision-making and outline responsibilities, things can head downhill incredibly quickly.
Founding a company with others is much like a marriage. You might not be able to imagine a future where you won’t want to be linked forever by your combined business creation. But, of course, we cannot see the future or how situations can change and evolve. With a well-crafted Founders’ Agreement, you can set out the details of how the company will deal with issues that may arise. Beneficially, you’ll be able to manage everyone’s expectations and minimise any perceived unfairness. And, hopefully, any hurt feelings.
The difference between a Founders’ Agreement and a Shareholders’ Agreement
To start, a Founders’ Agreement is similar to but slightly different from a Shareholders’ Agreement. A shareholder is a person who owns a share of a company. A shareholder has certain rights that are defined by company law in your jurisdiction and the Articles of Association or Constitution of your company. Typically, these rights include the right to receive dividends from the company, the right to vote at a general meeting, and the right to receive a return of capital if the company is liquidated.
A “founder” is commonly understood as the “entrepreneur who started the business”. Legally speaking, the founder is “the first shareholder” of a company. Basically, you draft a Founders’ Agreement before the company incorporates. Whereas a shareholders agreement comes after the company is incorporated. Also, the content in a pre-incorporation Founders’ Agreement is typically very brief, whereas a shareholders agreement holds a great deal more detail.
The nuts and bolts of a Founders’ Agreement
A solid Founders’ Agreement needs to clearly state a number of details that you may —or may not— have thought of yet. It is an excellent document to plan for the future of the business. It’s ideal to put down in ink how you will divide up the business and what will happen when things inevitably change in the future. These details include the capital put in by each founder; the individual roles and responsibilities; the percentage of shares held by each founder; the intellectual property details; and, importantly, what will happen when one founder wishes to exit the company. Additionally, it’s important to note if the leaving member faces restrictions from competing with the business after exit.
Putting all this down on paper doesn’t mean that roles and protocols can’t evolve and change. But, having clear roles and a defined management system allows everyone to know upfront how they will operate the business. It’s also important to differentiate a founder from a CEO and minimise confusion over how things will function as the company grows. It cannot be overstated how important it is to have a leaving strategy outlined. As much as you feel the partnership between yourself and your other founders may last forever, the future is uncertain. Planning for it will lessen the pain if a founding member does leave. If you don’t plan for the event, the enterprise risks to your business are enormous. Nailing down your vesting terms is paramount.
Additionally, establishing the ownership rights to your business’s intellectual property is another important point. You will want to know from the start if the ideas and/or technology you’ve developed will belong to you if you leave, or will stay with the company to help it evolve and grow.
DOCUMENT: Founders’ Agreement
Recap of key points
When drafting a Founders’ Agreement, although you need less detail than in a Shareholders’ Agreement, it is important to focus on a number of key clauses. In particular:
- Project description;
- Capital contribution of each founder;
- Percentage of shares held by each founder;
- Vesting of shares;
- Remuneration of founders;
- Role of each founder;
- What happens when one founder wants to exit the company and what happens to his or her shares;
- Whether the founders will face restriction from competing with the business of the company after they exit; and
- How the company’s confidential information and intellectual property will be protected.
This article does not constitute legal advice.
The opinions expressed in the column above represent the author’s own.
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