Hope for the best, plan for the worst.
Every startup lawyer agrees: co-founder conflict is best avoided. And it is best avoided by planning for it in a founders’ agreement. Not because you and your co-founders will necessarily devolve into litigious conflict, although it is best to not exclude that possibility. Rather: a founders’ agreement is the only way of systematically aligning expectations and reciprocal rights and duties among co-founders. A written contract, duly executed and legally binding, has a much more important function than setting the rules during conflict. It avoids conflict because it ensures that everyone is on the same page.
Indeed, not having a clear agreement between co-founders is first on Forbes’s list of the biggest legal mistakes made by startups. In this article, we provide a quick guide to the most important contract clauses that should be included in your founders’ agreement.
Each Founder’s Stake In, and Contributions Toward, The Startup
Clearly set out what each founder contributed to the startup to date, and what they commit to contributing in the future. This can be tricky: some contributions are easily definable and measurable (such as a capital contribution or a particular invention). Other contributions are more ineffable, but no less important. Describe all contributions as clearly as possible. This is the easiest way to ensure that each founder knows exactly what is expected of him/her, and has a ground upon which to demand something from another founder. As part of setting out each founder’s contributions, the agreement should also define their roles.
In addition to this, and ideally after you have defined each founder’s respective contribution and role, clearly set out each founder’s ownership stake in the startup. If your startup is a corporation, this will be expressed as a percentage share of the company’s stock. In addition to this, decide on the vesting terms for these shares.
Your startup’s approach to decision making will depend on the context: how long you’ve known each other, the type of business you have, the size and culture of your company, and your respective roles, to name only a few.
In most cases, your decision-making process will be organic and informal – and that is a good thing. However, it is important to agree on a contract term that establishes a mechanism for decision-making in cases where you are unable to come to an agreement about contentious business decisions. Perhaps you will never need to revert to that contract clause. However, if you ever do come to a gridlock about how to move forward, this could save your startup and the co-founders’ relationships.
In addition to each founders’ ownership of the business, the startup might also pay a salary to each founder. Or, alternatively, there might be a stage in the future where a founder wants to take out a loan or withdraw money from startup funds. It is best not to negotiate the terms of such transactions when they are brought up by someone. Deciding beforehand how you will determine and change remuneration and loans can avoid potential conflict down the line.
Mechanism for The Departure of A Co-Founder
This is, again, an example of a contract clause that will hopefully, and most likely, never be used. However, its absence can create legal uncertainty and high litigation costs that could easily have been avoided.
Shareholders’ rights need not necessarily be set out in a contract clause of the founders’ agreement. Often, these rights are set out in stock purchase agreements. However, be sure that you know and define co-founders rights with regard to their shareholding. This includes rights of first refusal, tag-along rights, and drag-along rights.
Intellectual Property Assignment
It is essential that all IP related to the startup actually belongs to the startup as an entity. This is one of the first things VC’s will want to see before investing in your company. Ensure that your founders’ agreement includes a term providing that the founders assign all their IP related to the startup to the company.
Hire a Startup Lawyer Today
The legal world can be a strange, scary place for a startup. LawTrades knows startups and can help you handle the paperwork from inception all the way to a liquidity event. Contact one of our experts today for help with your founders’ agreement!