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Importance of Co-Founders’ Agreement in Startups: A Complete Guide

Deepti Shikha

| Updated: Mar 24, 2020 | Category: Legal Agreements

Importance-of-Co-Founders’-Agreement-in-Startups

Beginning a new business involves a lot of risks. Often two or more people come together to apportion a startup. There are a lot of formalities that needs to be completed while launching a startup and a co-founders’ agreement is one of them. Founders of startups need not skip this step as this agreement will come to their aid if things do not go the way as planned. A co-founders’ agreement, like all other contracts, helps in navigating the founders day to day operations and also helps in clearing the differences in case of any issue. The co-founders’ agreement as a document can be made legally enforceable by just printing it on a non- judicial Stamp paper, which must be duly signed by the concerned parties with the appropriate stamp duty varying in different states.

What is a Co-Founders’ Agreement?

  • A co-founders’ agreement is a legal document which specifies the terms and conditions between the co-founders’ of a startup, regarding as to how the business will be operated between them.
  • This agreement provides insurance in case of disagreement between the co-founders.
  • The drafting of a co-founders’ agreement must be on based on the lines of business. It must mention all the provisions relating to the factors for which the co-founders will be liable.
  • This agreement must be accurate, and hence it is better to consult a lawyer or a firm to help in drafting it accordingly.
  • This document can save the founders from getting into any type of confusion in case if there is any change in situations, whether it is psychological or financial.
  • Basically, a founders’ agreement is an official contract signed between all the co-founders of a firm or business. This document specifies all the responsibilities, ownership, and also the initial investments made by each of the founders of the startup.
  • Hence, a founders’ agreement must be made at the stage incorporation of the business as it will lay out the roles and responsibilities of the co-founders of the firm.

What are the Key Provisions of a Co-Founders’ Agreement?

The essentials to be found in any founders’ agreement are as follows:

  • Definition of the business
  • The names of the co-founders of the business.
  • Validity of the founders’ agreement
  • Goals of the company
  • Details of capital rose both by founders as well as investors
  • Ownership details in the company
  • Roles and responsibilities of each of the co-founders
  • Compensation or salary drawn by each of the co-founders
  • Details of exit formality for founders or Exit clauses
  • Dissolution of the firm
  • Details of dispute resolution
  • Miscellaneous provisions like assignment of intellectual property rights, non-compete clauses, vesting of shares, equity breakdown and many more

Ownership Clause

All the founders of startups own a part of the business even though the ownership may be divided based on their investment. Each co-founder agreement must mention the following details:

  • The number of shares owned by every co-founder.
  • The total amount of capital invested by a co-founder.
  • Voting rights of every the co-founder.
  • Division of profits between co-founders.

Roles and Responsibilities

The roles and responsibilities of every co-founder are different based on their skills and capabilities. The co-founders must declare their roles and duties in the agreement and also lay down the activities of the business for which they will be individually responsible.

The Names of Co-Founders and the Business

The agreement must name the founders and the company. The name of the business and owners must be clearly specified in the agreement.

Length of Validity

Finally, it must be clarified as to how long the co-founders’ agreement will remain valid. It is not legally binding to continue working for the business forever, so it is suggested to decide the validity period of the agreement.

Company Goals

This clause can change the way business changes and grows, but it is better to mention in the clause regarding the goals of the company. What products to offer? Or how the business will look to a consumer, a competitor, or an employee?

To predict how a company will operate is not legally binding, but it is just a business model to be planned before.

Confidentiality

A provision which prohibits explicitly any founder from soliciting any business information or sensitive information of any client or employee in case he leaves must be revealed in the co-founders’ agreement. This clause prevents any co-founder who leaves the business in the future from duplicating the business idea.

Winding up of Business

The co-founders’ agreement must lay down the rights and liabilities of the founders in case of winding up of business. The provision also includes, how the assets and liabilities of the business will be distributed.

Capital and other contributions

Generally, one or more co-founders put in some capital in the early stages of the company.  The agreement shall specify each founder’s contribution and the basis of contribution for example, debt, equity loan etc.

Remuneration

Founders must decide if and when they will take a salary or they will take other forms of compensation other than shares. In this part reimbursement of expenses incurred by the individual founders must be decided.

Departure

Founders must ensure that in case a founder decides to leave and sell their shares than the other founders have an option to purchase those shares. These are important as the departing founder can sell their shares to an unknown third party.

Dispute resolution

As disputes regularly arise in co-founder situation, it is vital to set out the process of how the differences will be resolved. This may engage a series of steps such as having an informal meeting if no agreement can be reached then to have mediation or another alternative dispute resolution process.

Exit Clauses

Finally, a founders’ agreement must mention the circumstances of exit, i.e., what happens when a co-founder has been consistently underperforming he can be asked to leave the company, or the person can be terminated.

Importance of Having a Co-Founders’ Agreement

A co-founders’ agreement is a brief idea of how the co-founder relationships will work in the future or how the company is structured and what is the contribution of the owners in business. It is the key to any type of business structure.

In many cases, this document is optional, but it is not recommended to start a business without one. Co-founders’ agreement is an insurance against the unexpected.

Some of the reasons why having a founders’ agreement are essential is mentioned below:

  • The first one is that it helps to outline the responsibilities of each member and also helps in the decision-making process. For instance, through this, one can decide who will be in charge of operations and who will be the in-charge of marketing. Based on the strengths and weakness of each person, responsibilities can be divided.
  • In the founder agreement, the state of ownership, whether it be share or equity and the strategy of the business, must be mentioned. This agreement states the profits from the business concerning the amounts of share of each of the member according to his contribution towards the company.
  • The third reason is that it helps in making the strategy and also taking action in case any member wants to quit the startup and start something of their own.
  •  The fourth reason is that the founder agreement ensures the intellectual property is safeguarded under the business name also will avoid making any mistake of assigning the copyright ownership to an individual.
  • This agreement helps in carrying the future transactions which affect the business in a better way.
  • The sixth reason is that in case the company needs to be shut down because of different reasons, the agreement will include a clear plan as to how the company will be dissolved and how share proceeds will be generated because of dissolution.
  • The last reason is that it helps in having a contingency plan, in case there is any unpredictable situation like death, loss due to underperformance or severe accident.

How to Make a Co-Founders’ Agreement?

Co-founders’ agreement is a legal document, and it becomes difficult for individuals to draft one. Here, a step by step procedure has been mentioned as to how it should be drafted:

  • Step 1– The first step is to find a template. There are several templates which are available online; you can choose one of them. You can also make your own by selecting the best parts from each template and then combining them.
  • Step 2– After the selection of the template, fill the required details which are easy and does not require any legal help like the Names of founders, company name, company addresses, companies’ address, phone numbers, its date of inception, state and country etc. Doing this in advance will save both the time and energy.
  • Step 3– In the third step; write down all the essential details like compensation, responsibilities, rules, equity, termination clause etc. It is better to have a discussion between all the founders regarding this point to avoid any sort of confusion.
  • Step 4– Visit a lawyer who will help you understand what is lacking in your founders’ founder’s agreement. The lawyer will help you complete your template in case it has any loophole.  The lawyers will prepare a complete professional agreement. 
  • Step 5– The Co-founders’ agreement will have many changes, and it is advisable to take the help of professionals who can guide you through the process. After making the changes, the lawyer will make it a binding legal document.
  • Step-6: After completion of the process, the final step is to get signatures of all the partners and make it a legal document.

Why Enterslice?

At Enterslice, we have a team of efficient lawyers who will help you in getting through this agreement in a hassle-free manner. Our professionals will help you in drafting the agreement accordingly within a short period.

Conclusion

Lawyers and entrepreneurs recognize that a Co-founders’ agreement is an initial assessment of how things stand when the business is new. You can comprise procedures in this document for making crucial changes and updates. Founders’ agreement is optional, yet it can end up being extremely useful if driven because it can be fundamental in producing better understanding between co-founders.

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Deepti Shikha

Deepti is a Law graduate with an avid interest in reading and very proficient in summarizing legal cases. She has enough experience in handling legal affairs of the company. In the initial days of her career, she has worked as a legal researcher and has 3+ years of experience.

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