Founders’ Agreement

Most founders begin their startup with their friends, colleagues or someone who they have known in the past. The earlier social relationship is now an economic relationship and it is essential to have a strong contractual agreement. There are some pertinent points that you need to discuss with your co-founder(s) and the best time is upfront, when you are freezing on the idea / broad goals and preparing to start.

Some founders actually go shopping for a co-founder. But before you startup, could you also check on the ‘Chemistry’?  Yup! You would have heard about trust, passion, complimentary skills required for the business. They are absolutely important, but without chemistry it just doesn’t seem to work.

Equity Structure:  Do decide about the shareholding and vesting(if a partnership firm, then contribution ratio and profit sharing). This is also related to other aspects such as roles that each co-founder would play, the amount of cash investment, salary to be drawn by co-founders and others. There is no one formula, but generally, the person who has invested cash and also takes a very active role in the company, would obviously get a higher stake compared to the person who just invests.  While on this point, also discuss future financing capabilities of the co-founders, openness to debt-financing and equity dilution scenarios.

Roles and responsibilities:  In a startup, co-founders pretty much do everything between themselves, until they have the initial employees and some organizational structure.  But still, it is necessary to have a sense of who does what and responsibilities. It not only helps in having adequate discipline amidst chaos in the initial period, but also establish commitment and accountability.

The key take-aways from this discussion would be to identify the decision maker, would it be the CEO / Chairman of the Board/ or a majority shareholder.  While it is great to have a consensual approach, it is imperative to have one person who will have the final say. Closely observing how the decision evolves from this discussion gives you a lot of insight. Be tactful when you discuss designations, some are hung-up over a designation!

The other interesting dimension that it helps is in identifying each co-founder’s personal goals – a profitable venture, a life-style business or exit at high valuation.

It is a good time to think through the authorization for operating the bank account as well.

Broad contours of the business: Most startups evolve over time.  While it is hard to foresee the future requirements, you can check-out your co-founders flexibility / rigidity on a given idea and execution. I have seen a startup team disintegrate because the co-founders came together to build a product company and the market realities (cash flow constraints) forced the company to ‘also’ do services, which consumed a large portion of the startup team’s bandwidth.

Salary:  Till the time the business earns revenues, the co-founders need to sustain themselves.  Expecting a salary during the very early stages is hard. However, a discussion on the compensation structure, including performance based incentive in the form of sweat equity/ ESOP, though sensitive is crucial.  It becomes a touchy point especially if one of them has invested more than the other. But, a candid discussion reduces the heart-burn later.

When things go wrong:  You should discuss on the ‘give-up’ strategy; that all the intellectual property developed by the startup will belong to the company; that a co-founder will not continue / start / participate in another similar or competing business; that a co-founder can be asked to leave if she is not performing and the modalities; most importantly, how would the shareholding alter if a co-founder left.

A co-founder leaving is emotionally draining, but do mitigate the risk and pain by discussing these points upfront.

A Founders’ Agreement primarily captures the outcome of the above points.  You could either have a separate written agreement or make it a part of the charter documents.

What are your thoughts?

Disclaimer: This is not a legal opinion and should not be construed as one. Please speak with your attorney for any advice.

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