Founders’ Agreements: Why You Can’t Afford Not to Have One
One way to place both yourself and your startup business in a high-risk position is to wing it when it comes to formal agreements between you and your cofounder(s). I wrote a post last year on how to recover from a cofounder’s exit. This time I’d like to step back and focus on how to set things up correctly long before the relationship goes off the rails, your business strikes it rich, or you’re at odds over a major decision regarding the financial future of your business.
Founders’ agreements are an absolutely necessary piece of startup infrastructure, helping provide the foundation for a successful business. They set expectations, help guide decision-making, mitigate risk, and reassure investors that they’re not stepping into a mess.
Here’s what good founders’ agreements should cover:
Responsibilities and Decision-making
- One way to minimize the opportunities for major conflict between founders is to clearly define roles and responsibilities. For example, one founder is responsible for overall strategy and business development while the other has primary responsibilities for operations. Setting these out in writing and agreeing to them upfront as well as spelling out who makes the ultimate decision in a given arena or what you will do in case of disagreements over major decisions are absolutely critical.
- It’s rare that founders contribute equally to the business: either in terms of time or initial financial contribution. Come up with a split that is equitable when taking into account your relative contributions to date as well as how you expect that to evolve over time. The best agreements provide for vesting of ownership stakes over a period of time, so that founders’ financial success is aligned with that of the company.
- Make sure you and your cofounders have alignment on vision, objectives, and exit strategy. Your goals for exit will profoundly impact how you operate your business, how you structure operations, your financial management decisions, and how you build your team. You and your cofounders must absolutely be on the same page regarding overall goals.
- In the early days, much like dating, you might think your relationship will last forever — but that’s usually not the case. Specify how you’ll unwind the relationship in the event one or both of you wants out. The critical thing to avoid is someone who’s no longer participating in the company walking away with a chunk of shares or veto power over key decisions. You also don’t need the distraction of a protracted negotiation, or worse, legal action over who gets what.
Ownership of Intellectual Property
- Founders’ agreements should stipulate that all IP developed in connection with the business belongs to the company. That way, if your technical cofounder leaves for greener pastures or vice versa, his/her/your departure doesn’t sink the company. Securing your IP is basic good business practice. It’s also a condition of investment for most investors and any acquirers.
- What happens if an acquirer comes calling? This is closely related to the point I just made above. Thinking through and agreeing on exit strategy gives you a framework for evaluating opportunities, whether that be for partnerships, mergers and acquisitions, or a sale of part or all of your business. This usually also covers things like accelerated vesting and right of first refusal, among other things.
- What happens if you have to liquidate your company? How you will handle and split the proceeds from a disposal of the company assets, including intangibles, should be covered in your agreement.
While you can easily find template founders’ agreements, take the time to have an attorney review one before you commit yourself to a legally binding agreement. It may seem like a cost that’s not worth incurring, but believe me, getting it right initially and catching any glaring omissions or obvious ambiguities will more than pay for itself down the road.
What other provisions should founders’ agreements include? Share your experience and ask us questions in the comments section below or contact Early Growth Financial Services for financial support with your startup fundraising.
David Ehrenberg is the founder and CEO of Early Growth Financial Services, an outsourced financial services firm that provides early-stage companies with accounting, finance, tax, valuation, and corporate governance services and support. He’s a financial expert and startup mentor, whose passion is helping businesses focus on what they do best. Follow David @EarlyGrowthFS.