What is a Founders’ Agreement?
A founders’ agreement is a formal document that outlines each founder’s roles, responsibilities, rights, and obligations in a startup. Founders’ agreements are a common practice in the United States for startups and new businesses. Elements such as equity ownership, roles and responsibilities, intellectual property assignment, vesting schedules, conflict resolution, exit strategy, and protection of company interests are all addressed in such an agreement. These considerations are fundamental in the startup ecosystem.
A founders’ agreement essentially serves as a guide to manage the relationship among the founders’ and to prevent conflicts. Key elements that are typically seen in a founders’ agreement are:
- Equity Ownership The division of ownership shares among the founders.
- Roles and Responsibilities The specific roles and duties each founder will take on within the company.
- Intellectual Property (IP) Assignment Clarification on who owns the IP and how it is managed.
- Decision-Making ProcessThe method by which decisions will be made, including voting rights and procedures.
- Vesting Schedule Terms that specify when and how founders earn their equity over time.
- Conflict Resolution Mechanisms for resolving disputes among founders.
- Exit Strategy Provisions for what happens if a founder leaves the company, including buy-back rights and the treatment of shares.
- Non-Compete and Confidentiality Clauses to protect the company’s interests by preventing founders from competing with the company or disclosing confidential information.
- CompensationInformation on how and when founders will be compensated, whether through salary, bonuses, or other means.
- Duration and Termination: Conditions under which the agreement can be terminated or amended.
Having a founders’ agreement in place is not a legal obligation, however it is still important to ensure that the founders’ agreement complies with state-specific laws, as business regulations can vary by state. Consulting with a legal professional who specializes in startup law is advisable. A well-structured agreement is crucial for laying a strong foundation for the business, ensuring all parties are aligned, and mitigating potential disputes in the future.
When to use a Founder’s Agreement
While a founders’ agreement isn’t legally required to start a business, it’s a good idea to structure one as soon as you and your co-founders have your business idea. This agreement sets the rules for ownership and decision-making, helping to prevent disagreements and ensuring everyone understands their roles and responsibilities as the business grows. Here are some specific situations when a founders’ agreement should be created:
During the Formation of the Company
Once the decision to start a business together is made, and before the company is officially registered is a good time to create a founders’ agreement.
Before Seeking Funding
Before approaching investors, having a founders' agreement in place shows a clear structure and commitment among the founders, which can increase investor confidence.
To Define Roles and Responsibilities
Once the decision to start a company is made, discussions to clearly outline each founder's roles, responsibilities, and expectations commence. This makes for a good time to put a founders’ agreement in place to avoid conflicts and ensure smooth operation.
To Clarify Equity Distribution
To be able to address how equity will be divided among the founders, and agreement is a must. This can help prevent future disputes over ownership and contribution.
For Intellectual Property Assignment
To ensure that all intellectual property created by the founders is legally assigned to the company, protecting its assets.
To Establish Vesting Schedules
When a vesting schedule for equity needs to be set up, a founders’ agreement ensures that founders earn their shares over time. This can prevent issues in case a founder leaves early.
For Protecting Company Interests
This includes non-compete and confidentiality clauses to protect the company's interests and sensitive information.
Overall, a founders’ agreement should be created as early as possible to provide a clear framework for the company and ensure that all founders are on the same page regarding their roles, responsibilities, and the future of the company.
FAQ’s on Founders’ Agreements
- Why is a founders’ agreement important? A founders’ agreement is important because it clarifies expectations and reduces potential disputes among founders. It provides guidance on how important decisions will be made, how equity will be distributed, and what happens in various scenarios such as a founder leaving the company.
- What should be included in a founders’ agreement? A founders’ agreement typically includes provisions on equity ownership, vesting schedules, roles and responsibilities of each founder, decision-making processes, intellectual property ownership, dispute resolution mechanisms, and scenarios for handling founder departures or additions.
- Do we need a lawyer to draft a founders’ agreement? While founders’ can draft a basic agreement themselves, it is highly recommended to involve a lawyer experienced in startup law to ensure that the agreement covers all necessary legal aspects, complies with relevant laws, and protects the interests of all founders.
- Can a founders’ agreement be changed or amended? Yes, a founders’ agreement can typically be amended or updated as needed, especially as the startup grows and circumstances change. It’s important to include provisions in the agreement that outline the process for making amendments and obtaining consensus among the founders.
- What happens if a founder wants to leave the company? A founders’ agreement should include provisions for handling founder departures, such as buyout options, restrictions on transferring equity, and protocols for transferring responsibilities. These provisions help minimize disruption to the business and protect the interests of remaining founders.
- How does a founders’ agreement protect intellectual property? A founders’ agreement typically includes clauses that outline ownership of intellectual property created by founders during their involvement with the startup. This helps prevent disputes over ownership and ensures that the startup retains rights to crucial intellectual assets.
- Can a founders’ agreement prevent disputes among founders? While it cannot entirely prevent disputes, a well-drafted founders’ agreement can significantly reduce the likelihood of disputes by providing clear guidelines, roles, and expectations for all founders. It helps foster transparency and accountability within the founding team.
- Is a founders’ agreement legally binding? Yes, a founders’ agreement is a legally binding contract once signed by all founders involved. It governs the relationship between founders and provides a framework for operating the startup, making decisions, and resolving conflicts in accordance with the agreed-upon terms.