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What is a Founders Agreement?
A founders agreement is an official contract or legal agreement signed by the company’s co-founders when starting a business. This agreement defines each founder’s tasks, rights and duties, responsibilities, ownership, liabilities, and investment share.
- A founders’ agreement should be formed in writing rather than orally.
- Co-partners/parties are two or more partners who enter into the founders’ agreement together.
- All co-founders will sign the agreement immediately when the firm or company is formed.
The founders’ agreement’s goal is to avoid business disputes that may occur between co-founders over time. This agreement has outlined the founders’ plan, requiring them to behave within the parameters and adhere to the obligatory terms.
Founders agreements also aid in dealing with unforeseeable events, such as the death of a co-founder or resignation, directly impacting the business’s or firm’s ongoing growth and smooth operation.
Benefits of a Founders Agreement
Determining the Type of Business Entity
The founders' agreement will clearly state the nature and type of company the co-founders should establish, establishing the right course to take.
Outlined Business Plans
This agreement specifies the entity's vision and mission, as well as the short-term and long-term goals that must be met throughout time.
Designating the Roles and Responsibilities
Co-founders will inevitably have overlapping roles and functions without an appropriate framework for the allocated tasks. As a result, it is critical to define the duties and responsibilities of the co-founders following their areas of expertise, such as marketing, operations, finance, and so on.
Structure of Ownership
The founder's agreement will explicitly state the ownership structure pertaining to the co-founder's initial contribution or the percentage of equity shares held by the co-founder in the case of a firm, thus eliminating any future issues between them.
Decision Making
There will be an ideological dispute between co-founders at some point, and these conflicts must be resolved through the proper decision-making process. The founder's agreement will outline the procedures that will be followed during the decision-making process. If the voting mechanism is implemented, it should define the value of each founder's vote and propose a solution in the event of a deadlock.
Compensation Provisions
This agreement outlined the compensation plan that would be implemented if any of the co-founders broke the terms of the agreement. The percentage of remuneration to be paid to each co-founder will be listed here.
Expulsion of Co-founders
Any co-founder can be fired from the company if they engage in fraudulent actions such as misuse of cash, sexual harassment, or working for other organisations. This agreement establishes a correct system for dealing with these scenarios and determining appropriate monies to be returned to the ejected co-founder.
Confidentiality
The founder's agreement included a second confidentiality clause that required founders not to share the business's secrets.
Critical Terms Used in a Founders Agreement
Founders
This section identifies the co-founders’ names and distinct roles and responsibilities inside the organisation.
Ownership
This section describes the business’s equity ownership structure and the proportion of ownership held by each co-founder.
Vesting
The vesting timeline for each co-founder’s equity ownership in the company is outlined in this section. Vesting is a strategy that assures co-founders receive their shares over time, often over four years, with a one-year cliff.
Management and Control
This section describes the company’s decision-making structure, including the method for making significant choices and the roles and duties of each co-founder in the decision-making process.
Intellectual Property
The founders’ agreement section handles intellectual property ownership and protection, including patents, trademarks, copyrights, and trade secrets.
Confidentiality and Non-Disclosure
This section describes each co-founder’s responsibility to maintain the privacy of the company’s proprietary information and trade secrets.
Termination and Exit
This section describes the situations that may lead to the termination of a co-founder from the firm and the process for departing the company, including the right of first refusal and buyout clauses.
Dispute Resolution
This section outlines the method for settling conflicts among the co-founders, which includes mediation and arbitration.
Documents Required For Founders Agreement
- Address verification for all co-founders.
- Proof of identity for all co-founders.
- Witness identification is required.
- A well-defined company goal.
- The total amount of equity shares held by each co-founder.
- The total percentage of each co-founder’s shares.
Major Clauses of Shareholders Agreement (SHA)
Management and right to appoint a nominee director
While shareholders have no say in day-to-day operations, they have the right to choose a candidate director under the terms of a shareholder's Agreement.
Information rights
The obligation of the Company to provide such information about the Company as a shareholder may seek should be included in a shareholders agreement, particularly for shareholders who are not also directors.
Right of First Refusal
It is usual practice for a shareholders' Agreement to require a departing shareholder to make an offer to the other shareholders at a predetermined price before selling their shares to a third party. With ROFR in place, the Shareholders cannot sell their stake to anybody who isn't a Party to this Agreement without making the acquisition available to the other Parties.
Drag-Along Rights
With this provision, the majority shareholders can force the minority shareholders to sell their shares to an unrelated third party on the same terms as the majority shareholders.
Tag-Along Rights
This provision safeguards the Company's minority stockholders. As a result, if the majority shareholders choose to sell their shares, the minority shareholders can participate in the transaction and sell their shares as well.
Anti-Dilution
This protects the value of the Company's Shares for current shareholders if new Shares are issued in the near future.
Confidentiality
Shareholders privy to nonpublic information about the Company should be required to keep such information secret and prohibited from using it in a way that could hurt the Company or its other shareholders.
Restrictive Covenants
Shareholders may agree to no longer participate in any other businesses in direct competition with the Company they already own under a shareholders' Agreement. Such covenants may be in effect during and beyond when the shareholder holds shares in the Company.
Dispute resolution
Disputes between shareholders can and should be resolved according to the terms of a shareholders' Agreement. This means disagreement cases are taken to court under the appropriate legal system. The Parties may also incorporate an Arbitration Clause in this Agreement. If a dispute emerges between the parties, they might take it to an arbitrator, agreed upon by both sides. The Arbitrator's ruling shall be final and binding on all parties to this Agreement.
Procedure for Drafting a Founders Agreement
The following steps are included in the method for drafting the founders’ agreement:
Once the drafting process is finished, double-check that all mandatory elements have been included and that there are no unclear clauses.
Include any other information that must be included in the agreement.
With the ratification of the aforementioned agreement, all co-founders should acknowledge that the final draft has been scrutinised.
After all co-founders have agreed to the terms of the agreement, it should be notarized on non-judicial stamp paper.
After notarising the agreement, obtain the signatures of all co-founders.
Seek expert advice before agreeing to avoid problems.