A Founders agreement regulates what happens in the event of co-founder fallouts, outline the responsibilities of founders, and explains how shares vest. Investors want to see one as it ensures the longevity of the startup.
In the startup world, things move at lightning speed and legal admin may seem like a waste of time. This post is here to highlight that there are certain legal documents that should be in place to ensure a healthy life for the startup. Often a founding team will incorporate the company and ‘go off to the races’. We encourage you to take a breath before you do this and put in place a founders agreement.
Aligning the founding team
You are still in the honeymoon phase of your startup and the excitement is palpable. This is normal. Starting a business is an exciting time. It is very important however to put in place safeguards to protect founders, investors and the company if things go wrong.
While there is overlap between a shareholders agreement and a founders agreement, they are separate documents. A founders agreement sits above a shareholders agreement and specifically regulates the relationship amongst the founding team. Remember, not all shareholders are founders.
A founders agreement is not a shareholders agreement
A founders agreement outlines the responsibilities of the founding team. It makes it clear from the onset why and when a founder can be terminated and what to do if a director leaves the company. There are several key terms in the agreement that you as founders will need to discuss and agree on. Let’s take a look.
Role and competing interests
Generally, a founder will also be a director. You should confirm this as it brings with it fiduciary duties.
The other key element of this term is to be transparent about external business interests. This disclosure requirement is to mitigate against the risk of conflict between the founder’s involvement with the startup and any outside interests. We recommend that the founders are required to disclose any external business interests to the board. The founders may only enjoy these external interests with the board’s approval. This includes interests they currently have or may have in the future.
Transparency is key. Disclose any external interests from the onset
Equity
Splitting equity amongst founders is one of the toughest discussions you as a founder will face. Factors like the amount of contribution, who came up with the idea, and how much money has been put into the startup can guide the decision. We recommend looking at equity split with a long-term perspective. You are going to war with your co-founders so incentives need to be aligned from the beginning. An equal split is usually the best way to solidify this.
Equity alligns incentives with the long-term vision in mind
To unpack the important elements here, ask the following questions:
- What equity does the founder have?
- When did they get their shares, or will they get them?
- What class of shares do they have, or will be getting now?
- Do they have a fixed number of shares or a percentage of the company?
- What percentage of the company’s shares do they have, or will be getting?
- How will the shares vest?
- Will the vesting schedule accelerate if the startup is sold?
Investors will generally expect that the founders’ shares vest over a period of time. We recommend a vesting schedule in which shares vest over a period of 4 years, in quarterly tranches, with a 1-year cliff.
A cliff is a period in which no shares vest. Vesting milestones can be based on performance or time
Leavers
Sometimes a founder will leave the company. To deal with this, the founder’s agreement needs to cover what will happen to a leaver’s vested and unvested shares. The context of a founder leaving the company is relevant and you should deal with each scenario separately. We suggest having four buckets of scenarios:
- Bad faith leavers
- Good faith leavers
- Compelled leavers
- Voluntary leavers
When drafting a leavers clause you need to consider each bucket and decide how the following will be dealt with:
- What happens to their unvested shares?
- What happens to their vested shares?
- At what price will the leaver have to sell their vested shares (if applicable)?
- When will the provisions apply? During or after the vesting period, or both?
Founder restrictions
A founders agreement should detail whether a founder is restricted from setting up or joining a competing business. A common restriction is that a founder may not be involved in a competing business during and for a period of 6 – 12 months after leaving the startup.
How can we help?
A founders agreement is a very context-sensitive document. Our startup lawyers have experience in guiding the discussion and drafting the agreement accordingly. Reach out to us if you would like us to help you.
