Significance of Founders’ Agreement
What is a Founders’ Agreement?
A Founders’ Agreement is an agreement that the founders of the startup enter into that governs their business relationship.
For each founder, the agreement defines his or her rights, responsibilities, liabilities, and obligations towards the startup or the company. Generally speaking, this agreement covers matters that may not be covered by the company’s other documents such as employment contract, shareholding agreements, ESOP agreement, articles etc.
The agreement at its core covers how the founders will work together to move their business forward all the while protecting their own interests.
What are the various elements of a Founders’ Agreement?
Generally, these can be grouped in four groups as depicted below:
Group 1 defines the responsibilities of each of the founder towards the startup, and the decision making process. It also lists down the joint responsibilities, if any, that the founders have. Many times there are disputes between the founders as to who should come on the board or committees – this agreement covers the process agreed upon between the founders to avoid this situation. Similarly the agreement defines the process to being in new cofounders and hiring senior employees. The very important issues who is the CEO is the startup and the reporting relationship between the founders is also covered here. Dispute resolution process is also covered here.
The second set of clauses over the commitment that each founder has to give to the startup. The issue whether any founder can launch another startup (even if non-competing) is also covered here. The commitment can in terms of time, capital or transfer of IP that a founder already has. Many founders are deeply involved in technical work and develop IP as a result of this.
The third set of clauses cover the equity ownership division between the founders. It will also define the vesting schedule of the shares. A very important element that gets covered here is the salary that each of the individual founders will draw from the startup and how it will change over time. Another very part that is covered here is related to the performance measurement of the founders and what shall happen if the performance is not upto the mark.
The last set of clauses cover the restrictions on the founders on selling their shares. These clauses also covers what happens to the founder’s shares if he / she wishes to move on and leave the startup. The unforeseeable situation of one of the founders dying is also covered here. There could also be clause on non-compete e.g. if a founder leaves a company then he cannot work in a similar business for an agreed upon period.
What are the common mistakes in Founders’ agreement?
There are four mistakes that are generally observed:
- Not clear division of duties or failing to divide duties according to each founders’ skill
- Lacking consistent decision-making thresholds in each founders individual duties
- Requiring unanimous consent on most of the decisions and neglecting to articulate deadlock provisions
- Assuming that implicit understandings exist that defeats the very purpose of writing an founders’ agreement