Founders Agreement Overview
The founders’ agreement is an official contract or a legal agreement executed between the co-founders of the company while setting up a business. This agreement elucidates the roles, rights and, duties, responsibilities, ownership, liabilities, and investment proportion of each founder.
A founders’ agreement should be made in the written format, not by an oral.
Two or more partners jointly can enter into the founders’ agreement called co-partners/ parties.
All co-founders will enter into the agreement exactly while incorporating the business or company.
The objective of the founders’ agreement is to avoid disputes regarding business, which may arise over time between co-founders. This agreement apparently set out the strategy of the founders, who should act within the ambit and should follow the mandatory provisions laid on.
Founders’ agreements also help in tackling uncertain occurrences like the death of the co-founder, resignation, which directly affects the sustained growth and smooth running of the business or firm.
Benefits of a Founders Agreement
Determining the type of business entity: The founders’ agreement will clearly mention the nature and type of entity that should be established by the co-founders thereby setting the proper path to be followed.
Outlined business plans: This agreement describes the vision and mission of the entity and sets the short term and long term goals to be achieved over a period of time.
Designating the roles and responsibilities: Obviously, there will be overlapping roles and functions between co-founders without having a proper framework of the assigned roles. Therefore, it is important to designate the roles and responsibilities of the co-founders, in accordance with their area of mastery like marketing, operations, finance, etc.
Structure of ownership: The founder’s agreements will clearly specify the structure of ownership pertaining to the initial contribution made by the cofounder or the percentage of the equity shares held by the cofounder in case of a company, thereby avoiding any future conflicts in between them.
Decision making: At a certain point in time, there will be an ideological conflict between co-founders, So these conflicts are to be handled through the proper decision-making process. Here the founders’ agreement will formulate a procedure to be followed during the decision making process. If the voting system is adopted, then it should define the value of votes for each founder and provide a solution in case of a deadlock situation.
Compensation provisions: This agreement laid down the scheme of compensation to be carried out, if anyone of the cofounder has violated the provisions mandated. Here, the proportion of the compensation to be made will be mentioned for every cofounder.
Expulsion of co-founders: Any co-founder can be evicted from the company for indulging in fraudulent activities like misappropriation of funds, sexual harassment, and getting employed with other organisations. This agreement ensures a proper structure on how to deal with these situations and sorting out appropriate funds to be reverted to the expelled co-founder.
Confidentiality: There was a separate clause on confidentiality in the founders’ agreement, which makes an obligation for founders to not reveal the secrets of the business.
Checklist: key provisions of the Founder’s Agreement
Equity ownership: One of the most important provisions of a founder’s agreement is demarcating the equity ownership of each of the co-founder of the company. This equity ownership will be determined by considering the various factors like money invested, exposure, etc. This evaluates the jurisdiction of the voting rights of each co-founder.
Vesting of shares: If any one of the founders exits from the company, a proper pattern of vesting the shares should be ruled out in the agreement. The vesting of shares can be done in two ways, they are;
- Time-based vesting: Under this method, the shares of founders will be vested in proportion to the span of years invested by them. If any of the founders have been relieved or ousted from the company before the expiry of his/her term, then the outstanding shares will revert to the company. Here, the performance of the founder will not be taken into consideration.
- Milestone vesting: Under this method, the shares will be vested with respect to the milestone achieved by the company. If the founder exits the company before achieving this milestone, then the shares of the aforementioned founder will not be vested with him/her.
Constricted transfer of shares: This agreement should have another important clause related to the restricted transfer of shares of the founder. It may provide a clause of the lock-in period, which mandates the founder not to transfer his/her shares for a certain period, before the expiry of his/her term. Similarly, the method of valuation of the shares of the founder should be sorted out, before the expiry of his/her term.
Allotment of intellectual property: The innovative ideas or inventions created by the person enjoy the benefits arising from it, and it remains the property of his/her. So here, the agreement should explicitly state that the intellectual property rights developed by the co-founders are allocated or owned by the company. and on the occurrence of any issues, it cannot be entertained by any individual.
Most of the companies will obtain intellectual property, initially in the name of co-founders. Later, it is assigned to the name of the company. The valuation of the company is determined by the intellectual property, including the clause in the agreement which will avoid future disputes.
Restraint on trade: An agreement should be made in the form that no founder should indulge in any of the activities which conflict with the objective of the company. For instance, if any of the founders have decided to relieve from the company then he should not engage in any competitive business for a stipulated year from the date of exit.
Terms of employment of co-founders: The employment of co-founders should be full-time with the company. This agreement should elucidate the terms of employment, their roles, compensation, and benefits of each founder. There might be separate contracts regarding the terms of employment among co-founders, including their perks and benefits.
Dispute resolution: In case of any dispute arising between the co-founders, there should be an appropriate mode of dispute resolution mechanism, to be present. For example, if founders mutually agree to terminate the company, then the most preferred option for resolving this dispute is arbitration, mediation, etc.
The procedure of drafting a founder’s agreement:
The procedure for drafting the founder’s agreement involves the following steps;
- The draft of the founder’s agreement is prepared by including all the required fields, like objectives of the company, terms, and, conditions to be followed by the co-founders.
- Once the drafting process is complete, check if all mandatory provisions have been included, with no ambiguous clauses.
- Add additional information that has to be furnished in the agreement, if required.
- The final draft should be acknowledged by all the cofounders, that it has been scrutinised with acceptance of the aforementioned agreement.
- Once all co-founders have agreed to the agreement, it should be notarized on a non-judicial stamp paper.
- After notarizing, get the signature of all the co-founders on the agreement.
- Before entering into the agreement, get expert guidance to avoid disputes.
FAQs on Founder’s Agreement
What is the need to make a founder’s agreement?
The founder’s agreement will restrict co-founders from engaging with other employment opportunities, even if they are relieved or ousted from the company.
Should the founder’s agreement be notarized?
Yes, the founder’s agreement has to be executed on non-judicial stamp paper for respective value and get notarized from the notary person, in order to make the agreement a legally enforceable one.
Is there any penalty for breaching the founder’s agreement?
Yes, but it depends on the severity of the dispute! For example, the shares of the co-founder will be vested with the company if he violates or breaches the agreement.
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