Why Your Start-Up Needs a Founders Agreement

Introduction

So, you have this business idea you want to execute with your friend. You are the technical one and will provide all the technical know-how and capabilities for the business. Your friend is a marketing and accounting guru and will provide the needed marketing push and accounting frugality that’ll promote and keep the business. You both know what you want to do in the business and have agreed on a profit-sharing formula. You’ve both been friends since Uni and trust each other so that should be enough, right? Well, no actually, its not. Every business needs more than trust to succeed and one of the foundational documents any new venture would need is a FOUNDERS AGREEMENT.

Simply put, a founders agreement is a contract that elucidates the rights, roles, responsibilities, and obligations of each founder of a business venture. It is legally binding and aims to safeguard the interests of each founder while forestalling any possible conflict that may arise.

Usually, founder’s agreements are presented to other founders before the incorporation of a start-up. It defines the roles, responsibilities, and liabilities of each partner and also assigns IP rights among co-founders. A founders agreement is essential when demonstrating the seriousness of your start-up.

Importance Of A Founders Agreement

Founders agreement usually serve as the bedrock of any new business formation with more than one founder. It sets the tone and lay the groundwork for how you interact and manage the business as a team.

One of the main reasons to have a founders agreement is that it establishes ownership roles and responsibilities. It ensures that each partner in a new venture understands their roles and responsibilities within the venture. This also includes matters such as profit and loss sharing formulas, intellectual property rights assignments, financial obligations and debt resolution, etc.

Another reason to have a founders agreement is that it would outline guidelines for dispute resolution. In a founders agreement, dispute resolution mechanisms would be spelt out that each founder can explore to settle disputes. This allows founders to agree from the onset how they would handle disputes, thereby reducing friction in the future. A founders agreement in the same vein would provide rules surrounding the dissolution of the business venture.

Significantly, one major advantage of a founders agreement is that it protects minority shareholders. Now, it doesn’t just protect minority shareholders, but, the protections a founders agreement offers to minority shareholders in a business venture are quite significant. It helps minority shareholders spell out areas in which they would have a say and voice in during the running of the business. It also protects minority shareholders from arbitrary decision making of majority shareholders. Minority shareholders will also be aware of their financial obligations and liabilities as regards the business. This will prevent minority shareholders from bearing more burdens than they should in case of company debt situations.

Founders agreements also helps with perception. The existence of a founders’ agreement gives investors and partners the idea of professionalism, thus boosting their confidence in the future of your start-up. It solidifies the seriousness of your business formation and it provides a basis for structuring founders’ relationship through the use of essential clauses in the agreement. They are also attractive investing tools since they signal to investors that you are organized and methodical, even when bootstrapping.

Essential Elements Of A Founders Agreement

Like any contract, founders agreement contains standard provisions and guidelines. These essential clauses HAVE to be included in your founders agreement.

1. Names, Roles, and Responsibilities of the Founders: It is necessary to clearly define each person’s role and duty in the business venture
2. Ownership and Powers: The number of shares or equity stake of each founder should be clearly stated in the agreement. It must also contain clauses on the powers exercisable by each person and any limitations which apply.
3. Vesting Clause: By subjecting equity to a vesting clause, a start-up is effectively ensuring that a founder or co-founder is committed to the business venture long term and would not hold the start-up down.
4. Intellectual Property Ownership: At the commencement of a business, various co-founders create intellectual property (IP) for the business entity. It is imperative to ensure that such IP belongs to the start-up itself and not the individuals behind its development, except the intentions of the founders are otherwise. This way, if an individual decides to leave the enterprise, the start-up does not lose the IP.
5. Remuneration and Compensation: To avoid any uncertainty or conflict in a business venture, it is necessary to have a spelled-out plan for remuneration and compensation, considering any future changes which may occur.
6. Dispute Resolution: It is essential to include the method to be adopted in resolving disputes as conflicts are usually inevitable in any business. The mode of dispute resolution could be Alternative Dispute Resolution (ADR), litigation, or any other means of dispute resolution. I usually recommend litigation as a last option.
7. Exit Clause: The circumstances under which a founder may exit from the start-up and be released from his or her obligations should be mutually agreed upon.

These are just some of the essential elements of a founders agreement as some others such as capital contribution requirements, confidentiality clause, contractual communication clause, choice of law clause, representations and warranties, non-Competition clause, etc are also essential to creating a founders agreement.

Conclusion

In conclusion, in order to create a founders agreement, you as a founder need to do two fundamental things;

1. Sit with your business partner and agree on compensation, equity, responsibility, role, and any other obligations or concern that should be identified, discussed and specified.
2. Hire a lawyer to draft the agreement.

 

Adeola Onikoyi is an experienced corporate solicitor that can be reached via [email protected]