Understanding Founders Agreement: A Comprehensive Guide

The 24six9 founders' community is brimming with startups at various stages of their entrepreneurial journey. Some may have already established themselves, while others are hunting for cofounders, hiring the right talent, finding sources of funding etc. But one stage of the startup roster that garners the most questions is setting up founders' agreements. We’re here to help alleviate some of the most common worries and woes regarding the legalities within a founder's agreement. Let’s dig in.

A Founders Agreement is a legal document that establishes expectations, responsibilities and protections for all parties involved in a startup. It sets the foundation for a successful partnership, as well as ensuring investors have a comprehensive understanding of the intricacies of the startup. Formalizing the partnership is an essential step that some startups don’t see the value of, so we’re here to give you reasons.

Why You Should Have a Founders Agreement

We’ve heard it all at 24six9. From cofounders getting a payout because they never exited a startup they don’t work at anymore, to recruiting a co-founder that led the startup astray almost immediately. As such, a well-crafted founders agreement helps avoid a ton of red tape for a startup's future goals, and to keep investors updated on its inner workings. More than that though, a good founder's agreement can effectively:

Prevent misunderstandings: Through formalizing expectations and responsibilities that then mitigate conflicts and ensures all founders are on the same page re: their roles and contributions.

Provides legal protection: Startups aren’t immediately perfect, and disputes are likely to occur in the beginning. A founders agreement acts as a reference point to resolve such disputes, while also being a legally binding document that can be used if legal action becomes necessary.

Defines intellectual property: The agreement clarifies ownership of intellectual property and innovations produced by the founders, protecting the business's core assets.

Provides guidance on Exits and Removals: By specifying procedures related to the departure of founders, the agreement safeguards a startup against potential disruptions. Think of it as a safety net.

Facilitates operations: At its core, a founder's agreement can help define day-to-day operations by clearly delineating responsibilities, making it easier to manage a young startup.

So what should an ideal founder's agreement include? The list is long, and each founder's agreement can include specifics that need only apply to the nuances of each startup, but as a basic guideline, here are some key components of a founder's agreement:

1. Names of Founders and Startup

Start by listing all co-founders' names along with the startup's name, even if the company is not yet officially registered. This establishes a clear starting point for your partnership.

2. Startup Description

Include a brief overview of your startup’s mission and objectives. This helps align founders on the purpose of the business and sets the context for the agreement.

3. Ownership Structure

Define the ownership distribution among founders. It’s common to split ownership equally, but the shares should reflect the contributions and commitments of each founder.

4. Roles and Responsibilities

Clearly outline roles for each founder based on their skills. This division of labor is crucial in ensuring that all essential aspects of the business are covered and helps in holding each founder accountable.

5. Capital Contribution

Document what each founder will contribute to start the business, whether it be monetary investment, property, or resources. Also, include what will happen if the company needs additional funding in the future.

6. Expenses and Budget

Outline how to handle expenses and budget management. Specify who is responsible for managing the budget and how reimbursements will be processed for out-of-pocket expenses.

7. Taxes

Consult a tax professional to understand the tax implications for your startup and include basic tax handling procedures in your agreement.

8. Legal Decision-Making

Detail how legal and significant business decisions will be made, including voting rights and decision thresholds to prevent deadlocks.

9. Equity and Vesting

Specify how much equity each founder will receive and establish a vesting schedule to encourage commitment over time. A common vesting period is four years with a one-year cliff.

10. Compensation

Clearly state how and when founders will receive compensation. Consider including salaries, benefits, and any milestones for compensation changes.

11. Intellectual Property

Clarify the ownership of intellectual property. Determine whether the IP remains with the founders personally or is transferred to the company once established.

12. Removal or Departure of Founders

Outline procedures for dealing with a founder’s exit, including buyout terms and any restrictions on starting competing businesses.

13. Dissolution or Sale of the Business

Detail how to handle the dissolution or sale of the company, including what percentage vote is required for such decisions and the appropriate legal steps to follow.

Creating a meaningful Founders Agreement:

Crafting a founders agreement doesn’t guarantee alignment for everyone in the team, which is why its crucial to have in-depth discussions to create it, and not just approach it like a checklist. It is vital to take time to reflect on the underlying principles of your startup when crafting the agreement. Remember, the agreement is never set in stone, it’s a dynamic and ever-evolving document that should allow for updates as your startup evolves.

This also means it’s an exercise to openly communicate about expectations, so regularly revisit the agreement to keep it adaptive to circumstances. It’s also smart to keep a legal consultant handy, especially for the parts of the agreement that need compliance with local laws. This upfront investment can provide long-term benefits, and is always a good idea.

Remember, a founders agreement is an indispensable part of building a successful startup.

If you have long-term goals and plans for expansion, don’t think of the agreement as an optional document, but a vital, definitive and adaptive document to help your startup thrive.

Good luck!

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