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January 20, 2020

How to Create a Founders’ Agreement that Doesn’t Come Back to Bite You

Business Planning

You want to found a startup and think you have found the perfect cofounders. But before you go any further, you want to be sure you are all on the same page and memorialize that vision in a legally binding founders’ agreement (also known as a cofounders’ agreement). You may be envisioning yourselves as Jobs and Wozniak, but many cofounders end up in litigation like Mark Zuckerberg and the Winklevoss twins. Are you a bit vague about who the Winklevoss twins are? That’s our point. Here are some guidelines that can save you a world of hurt.

So, Just What is a Founders’ Agreement? 

A founders’ agreement, also called a cofounders’ agreement, is a legal contract that covers important issues when you are founding a company with other people. If you are setting up a partnership instead of an LLC or corporation, it might also be referred to as a partners’ agreement. The process of creating a founders’ agreement serves to pinpoint insurmountable differences with your cofounders before it’s too late. And should differences arise later, a founders’ agreement provides legal protection. 

Are You on the Same Page?

Starting what you believe will be a run-away success startup can be a real high. It can make you so high on the promise of the future that you ignore red flags. If your company is going to be successful, you and your cofounders need to be on the same page not just for now but in the future. This is far from a complete list for clarifying your vision, but you will want to sit down with your cofounders and honestly discuss issues such as

  • What is our mission?
  • What are our immediate and long-term goals? 
  • What is our initial offering?
  • Who are our target customers?
  • Do we want to stick to our category or expand into other areas?
  • What is our growth strategy?

We are certain you can come up with dozens of other issues in a short period once you give yourself time to think about them.

What Issues Should a Founders’ Agreement Cover?

The areas your founders’ agreement should cover depend on your circumstances and your industry. An experienced San Antonio business attorney can advise you on your own situation. However, there are some areas that are important to nearly every founders’ agreement.

What Is Each Founder’s Role and Responsibilities?

Clearly laying out the roles and responsibilities of each founder is one of the most important things to define in a founders’ agreement. You need to be sure that those in key roles have the skill sets for their jobs if your enterprise is to be a success. Also, keep in mind that there is a reason that many founders are removed from CEO positions as their companies grow. The skill set for envisioning and launching a successful business is not necessarily the same as running one day to day.

Also think about who will be making both major and minor decisions. Even though you may want to actively collaborate with your cofounders, if all of you plan to weigh in on all decisions great and small, you will create bottlenecks and vexation that can easily torpedo your business. Sure, discuss the big issues such as whether to open a European office or launch a new product. But you still need to decide who has ultimate responsibility for various areas. 

What Are the Initial Contributions?

Cofounders bring different benefits to a business. They may bring money, services or property, and often they do not contribute the same things in the same amount. You must record the value of all these contributions. You must also record if cofounders will continue to contribute capital or if the initial investment was the extent of their capital infusions.

How Will Cofounders Be Compensated?

The cofounders of your company will be playing different roles, and their compensation should not be the same. Rather, it should be in keeping with market rates for the roles and their experience. For example, a CEO is usually going to be making more than a CMO. Determine what salaries each cofounder will receive and under what circumstances that compensation can be modified.

What Is Your Equity Split?

Equity should not necessarily be divided equally. Equity ownership can be a difficult subject, but it’s one you need to address early and memorialize your decision in your founders’ agreement. You will also need to decide if you plan to allocate any equity to all or some of your future employees. 

Here are some issues to consider when determining your equity split:

  • Who originally had the idea for the basis of your startup?
  • What did each founder bring that is of particular value such as a patent? This could be anything that makes an important contribution to the company.
  • Are all cofounders working an equal amount of time or are some part-time?
  • What roles will each founder pay? The CEO will normally get more equity.
  • Did one of the cofounders bring an industry-wide reputation and a substantial network of resources to the table? All else being equal, they should probably get more equity than a cofounder who is not such a heavyweight.

What Is Your Vesting Schedule?

Once you decide on equity ownership, you need to determine how it will vest. If all equity is granted upfront, a founder could quit before doing the work to get the business off the ground. Usually, equity vests periodically little by little (perhaps monthly) over a course of years (usually about four). The vesting schedule will vary according to your circumstances, and this is a critical part of planning your business. You will need to determine if vesting is contingent on continuing to work in the business and cofounders should have the right to buy back shares if another founder leaves the business. If so, you will want to determine the price.

Who Owns the Intellectual Property?

You need an experienced business attorney to securely legally nail down that your startup owns all intellectual property. You want to be sure that neither a cofounder nor anyone else walks away with intellectual property that may be the lifeblood of your business. Intellectual property is not just the technology of your products. It also includes your business plan and your ideas for the future. You need to protect your IP at the very beginning, not after it’s too late.

What Happens if You Dissolve the Company?

Though it may be the last thing you want to think about, determine what could lead to the dissolution of the company, procedures for dissolving it and how assets would be distributed.

How Will You Resolve Disputes?

The world isn’t perfect and business even less so. Determine how you will resolve disputes should they arise. Binding arbitration is a common method.

Get Legal Advice – This Is No Time to Wing It

Sit down with an experienced San Antonio business attorney at the very beginning of your endeavor. They can not only draft a founders’ agreement but can help you with the myriad of other legal issues involved in starting a business.  Call the San Antonio law offices of Shann M. Chaudhry Esq., attorney at law, for a free consultation. Our experienced Texas attorneys provide business planning, estate planning and real estate law services. Contact us at (210) 646-9400 to schedule an appointment.

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