Entrepreneurs and start-up founders are rightly focused on perfecting their product or service and getting the business off the ground. However, agreements between partners and co-founders as to management, contributions, time commitments, and more, are often done with a handshake and without a written legal agreement. This is frequently a costly mistake that can be eliminated or minimized with a well-crafted founders' agreement.
What is a Founders' Agreement?
A founders' agreement is a written contract between a company's founders that outlines each founders' rights and responsibilities, the founders' obligations to one another with respect to the company, and the procedure for transferring ownership to third parties. The term "founders' agreement" is used generically to describe such agreements, but may take a different name depending on the type of entity formed (an LLC has an "operating agreement", a corporation has a "shareholders' agreement," and a partnership has a "partnership agreement," among others. If the start-up has begun operations but has not yet been incorporated, the founders can execute a "pre-incorporation agreement.")
A successful founders' agreement will be created early in the life of the start-up and will result from candid conversations between the founders and their attorney, whereby the founders must determine the structure of the founders' relationship between themselves and the company and how future conflicts are to be resolved - before a dispute arises.
What Should be in a Founders' Agreement?
A founders' agreement should cover issues that could arise and cause a dispute between the founders. These issues include, but are not limited to:
- Decision-Making Authority and Procedure – Which founder(s) will make the day-to-day decisions of the company? Who will make the major decisions of the company? Will certain decisions be made by a majority of founders, unanimously, or otherwise? Who will be the officers, directors, and/or managers of the company?
- Transfer of Ownership – If a founder would like to leave the company and sell or transfer their equity, what restrictions will apply? Does the founder have to offer the co-founders the opportunity to purchase his or her equity (a right of first refusal)? Must the co-founders agree to a new partner buying or receiving an interest in the company?
- Equity and Vesting – How much of the company will each co-founder own? Will the equity amount change over time? What thresholds must be met for the equity to vest?
- Outside Investment - Will outside investment be sought? (If so, a variety of SEC and other regulatory filings may be needed, even if the company is not publicly traded).
- Capital Contributions – What will each co-founder be required to contribute to the venture? Is the contribution made in cash or in-kind? When will the contribution be made? What if future capital contributions are needed to keep the company financially solvent?
- Commitment of Time/Services/Money – What are each co-founder's specific responsibilities? Is a certain time or effort commitment required? Is a co-founder simply a passive investor? What happens if these requirements are not met?
- Compensation – Salaries, draws, dividends, deferred compensation, and/or fringe benefits?
- Confidentiality, Non-Competition, and Non-Solicitation – What standard of confidentiality do the co-founders agree upon with respect to the company? Is a founder that leaves the company able to compete with the company or solicit employees or clients? If not, for how long and what distance?
- Dissolution - If the company holds valuable assets, e.g. intellectual property, how are the assets distributed if the company is dissolved?
When should a startup start thinking about a founders' agreement?
Day 1, before potentially-costly disputes arise between partners.
Moustakas Nelson LLC offers an array of transactional business services for entrepreneurs and startups, including formation of business entities, preparation and negotiation of founders' agreements, operating agreements, partnership agreements, shareholders agreements, as well as financing arrangements and private securities placements.