Starting a company is the beginning of a years-long journey filled with highs and lows. It can be intimidating to embark on that road alone. For many entrepreneurs, having a co-founder makes the journey more enjoyable.
Not only do you have the opportunity to work with someone that complements your skill set, but also you share the hardships and celebrate wins together.
But no matter how good the relationship with your partner is, you’re bound to run into differences down the line. When clashing opinions arise, a founders agreement can come in handy.
Founders agreements are especially useful if you choose a business structure that involves other shareholders, like a partnership, limited liability corporation (LLC), or corporation.
What is a founders agreement?
A founders agreement is a contract that a company’s founders enter where they set guidelines for their business relationships. Specifically, founders agreements outline each founder’s rights, roles, responsibilities, compensation, and obligations.
Also known as a co-founders agreement, this written legal document sets expectations for each founder so everyone’s on the same page. It also regulates matters not covered by financial or operating agreements, such as intellectual property rights and equity vesting schedules.
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Founders agreement vs. operating agreement
An operating agreement is a legal document specifically used by LLCs that sets expectations and guidelines for members of the LLC. A founders agreement covers the founders only, and it’s usually written before you create the company.
Operating agreements, on the other hand, are created when partners enter into an LLC.
Another difference between the two can happen if you bring in more partners than founders. Say you have three founders, and you bring two more people into your LLC. The three founders sign the founders agreement, but all five partners sign the operating agreement.
Why you should have a founders agreement
Founders agreements aren’t a requirement when starting a company. But here are a few reasons why you should consider one.
- It puts owners on the same page. Agreeing on terms and putting them in writing protects the business’s interests and the founders’ personal relationships.
Simon Bacher, CEO of edtech company Ling, shares, “My wife and I co-founded the startup, and we saw immense value and security in solidifying a founders agreement. We view it as sort of like a prenup.” - It provides structure to the business. This document covers everything from dealing with startup finances to dissolving the company.
- It creates dispute resolution guidelines, such as when to seek arbitration. Setting these up at the beginning can help you avoid going to civil court over disagreements.
- It can help secure investors. It shows potential investors that you’re organized and forward-thinking. Plus, it adds a layer of security to their investment.
How to write a founders agreement
There’s no standard structure for these contracts — they vary depending on factors like industry, location, and arrangements with co-founders. However, you’ll see some common sections in most agreements.
Here are the topics to consider adding and all the steps to take before you sign.
1. Come prepared with your point of view
Figure out what you want from the contract and business. Some questions to consider:
- What are my goals with this business?
- What values do I want the business to have?
- What does success look like to me?
When you come prepared with your priorities, it’s easier to have a productive discussion with your co-founders.
2. Draft the founders agreement
Once you and your co-founders agree on the major points, it’s time to start drafting the document.
Jonathan Tian, co-founder of CreditYelp, shares that they started the process using the Clara tool, but you can also use templates (more on that below).
Here are the sections to include for a thorough agreement:
Basic information
Start with the company name, founders’ names, and their positions. This prevents future non-founding employees from claiming a founder title.
This section can also include a breakdown of the ownership structure and a brief description of the business plan, mission, vision, and goals.
Roles and responsibilities
Outline which company functions fall under each founder’s area of responsibility. The founders’ roles should play into their strengths.
Should there be an overlap in a certain skill, set assignments. For example, say both founders want to be involved in marketing. The agreement can detail that Founder A will deal with inbound marketing while Founder B handles outbound marketing.
Other things you may want to include:
- Title expectations: Clarify them, especially if there are two or more founders.
- Description of roles: It avoids confusion and serves as a record in case a co-founder doesn’t perform their duties. Include a role’s limitations to prevent overstepping.
- Statement that roles are subject to review: A startup’s needs can change frequently in the early stages, so roles and responsibilities may change.
Decisions and rights
Besides equity shares and voting rights, founders have decision-making rights. These cover everything from minor approvals to major decisions, such as:
- Hiring key personnel
- Firing/removing a founder
- Board positions
A common pitfall is not accounting for deadlock situations. You can avoid this by electing a decision-maker and giving veto powers.
Some questions to consider:
- What situation calls for special decision-making powers?
- Who has the final say when you have an even number of founders?
- When the main decision-maker is unavailable, who’s next in line?
- Who overrides or vetoes a decision?
Equity and vesting
There’s no rule saying co-founders receive equal ownership. While many divide startup equity evenly among the founding team, others allocate it based on factors like who came up with the business idea, who shelled out the most initial capital, or who has the most experience or connections.
Discuss the percentage each founder gets and include a vesting schedule that details when they receive full rights to company shares. Add a clause stipulating conditions before equity ownership becomes available.
Most companies choose a time-based vesting term, ensuring founders work for a set period of time.
According to Harvard Business School, the usual term is vesting quarterly over four years, with a one-year cliff (or allowance). A one-year cliff means that you have to wait a full year before the vesting starts.
Some questions to consider:
- How much should each founder receive and why?
- Will they forgo a salary or receive shares?
- If they forgo compensation, how much will they get (equity and/or compensation) once the business earns a profit?
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Commitments and contributions
This section outlines what each founder shares in terms of time and other resources.
Some sections to include:
- Time and interest: How many hours are founders willing to dedicate? Lay expectations for work hours and effort, especially when partners don't work on the startup full time.
- Resources: What can founders bring to the table that contributes to the company's success? This could include:
- Capital contributions raised from bootstrapping or funding. Note contributions to avoid confusion, and add a confidentiality clause to protect the founder and business’s information.
- Network. A person’s network also could be a resource. For example, Lori Greiner’s QVC connections have helped many startups flourish on “Shark Tank.”
- Intellectual property rights. Discuss whom the product or business idea belongs to and what happens if the inventor leaves the company.
Dissolution and termination
What happens to your founders agreement if your startup fails or makes it to an initial public offering (IPO)? In these cases, it’s helpful to have dissolution and termination clauses that cover possible exit scenarios.
Include a clause that specifies conditions that might lead to the dissolution of the company or the termination of the agreement. For example, if you close an IPO, you consider the entire agreement void.
Also, stipulate that the agreement can only be considered terminated when agreed upon by all founders in writing.
Dissolution and termination terms should cover:
- Unvested shares
- Intellectual property
- Technical knowledge
- Company positions
Add clear conditions for when to terminate the agreement, and include nonsolicitation and noncompete clauses to protect the company.
3. Have a lawyer review your agreement
Have a lawyer look over the drafted agreement. They’ll review the document, discuss terms in detail, provide legal advice, and modify it until everyone is on the same page.
Vaibhav Kakkar, CEO of Digital Web Solutions, recommends that founders “get professional help from legal services to make sure you fully understand every aspect of an agreement before signing.”
In particular, ask if there’s any vague or unclear language that you should edit.
4. Sign when ready
Once everyone is happy with the agreement, it’s time to make it official.
A founders agreement is legally binding, so double-check the terms before signing. If something is unclear, ask your lawyer. Remember, you can refuse to sign.
Founders agreement examples
Now that you know what goes into this document, here are a few founders agreement templates and examples to help you craft your own.
- University of Pennsylvania Law: Includes provisions about ownership structure, transfer of ownership, decision-making and dispute resolutions, representations and warranties, and choice of law
- Harvard Business School: Includes provisions on ownership, competition restriction, and exit situations
- Rocket Lawyer: Includes basic provisions on vesting schedules, intellectual property, resignation, and termination
You’re going to go through many ups and downs with your partners. Creating a founders agreement is an excellent way to ensure you’re all protected throughout your business journey.
