A Complete Guide on Founders Agreements
Is your startup ready for investing? Learn everything you need to know about founders' agreements.
Many new ventures and new startups are formed by multiple individuals, collectively known as the founders. Sometimes long-time friends, sometimes former colleagues, other times like-minded individuals who came together specifically for the problem the startup solves. All of these different combinations of individuals, regardless of background, are startup founders and with that new title comes a new set of rules and responsibilities.
New startup founders that are forming a business, often enter into a Founders Agreement. We’ve gone in-depth into the typical nature of a Founders Agreement, what it is, and what it can mean for your startup.
What is a Founders Agreement?
A Founder’s Agreement is a contract. But not just any contract, a Founder’s Agreement is a specific contract that lays out the business relationships that the founders enter into and agree upon. The Founder’s Agreement contract specifically lays out the responsibilities, rights, obligations, and any liabilities of each founder. The Founder’s Agreement is in place to regulate matters that aren’t governed by any type of operating agreement or financial agreement with investors, but rather specifically ensures that each founder is clear on their specific role with and for the company.
Related Resource: How To Find Private Investors For Startups
What Are the Must-Have Items to Include in the Founders Agreement?
Now that it’s been established that a founder’s agreement is essentially a contract dictating the founding team’s rights, responsibilities, and role within the company, let’s get a little bit more specific. Thinking through all the possible items that could be in your founder’s agreement, we recommend starting with at least the following 10 to ensure the key details of the business are specifically covered.
1. Add Notable Names Including the Founders of the Company
While it may seem straightforward, be as detailed as possible and list out every single founder of the company by name, title, and even a breakdown of ownership if applicable. Capture as much detail as possible about the founding team that the Founder’s Agreement pertains to. It is also helpful to outline any other notable names that are involved at the early formation of your company. For example, if you have any early friends and family investors, advisors in the space, founding customers, founding partners, or subject-matter experts involved in any type of POC or validation study, list them out by name and role associated with your company. If they have a financial stake, outline the percentage ownership stake they have in the business as well and note if they would technically be considered a founder under this agreement.
2. Document Your Business Structure
Now that all key persons have been outlined by name and role, be sure to document the structure of your business. How your business is structured can affect the future of the company. Determine how your company will be structured – consider if it makes more sense for it to work as a partnership, LLC, C Corp, S Corp and consider all of the financial and structural implications that come with each option. Determining and documenting this from the beginning is key to building your business from a unified perspective and understanding.
3. Include a Broad Overview of Your Startup
Outline the mission statement and an elevator pitch of your startup. A broad overview is helpful to ensure all founder decisions moving forward are aligned to the same vision and mission, with a clear direction of the goal your startup has to accomplish. As the company evolves and grows, pointing back to the agreed-upon overview in the founder’s agreement can help dictate that change and direction as well but will ensure decisions are made with the same foundation in mind.
Related Resource: How to Write a Business Plan For Your Startup
4. Have an Expenses and Budget Report
Having your finances in order is key to the success or failure of any business. In the Founder’s Agreement, outline where your finances stand. Outline in detail any funding your team has received as a seed investment. Next, outline your company’s operating expenses to ensure all output of money is explicitly documented at the founding of the company and all founders are hyper-aware of the existing spend and burn rate of the company. Finally, outline a foundational budget that each founder has explicit input into. This will ensure that no matter each founder’s unique role or responsibility, there is an agreed-upon budget, especially in relation to the expenses and burn rate of the organization.
5. Include a “Who is Responsible for What?” Section
Depending on the makeup of your founding team, there may be a lot of different skill sets and ranges of expertise at the table. Having founders with many different backgrounds and skillsets can be a major advantage for your organization, however, with a versatile set of skills and a unified passion for the startup’s mission, it can be hard for founders to stick to the part of the business they own. Outlining a clear section that documents who is responsible for what in the Founder’s Agreement can ensure that every founder can contribute and master a key area of the business without trying to take on too much or double-dipping in another founder’s role or assigned lane. This will ensure the business scales effectively and every founder appropriately commits to what they will bring to the business. This section can also help define and structure the titles and growth path for each founder and the functional direction of the organization based on which roles are defined and taken on by the founding team first.
6. Management and Legal Decision-Making, Operating, and Approval Rights
Piggybacking off of the responsibilities section of your founder agreement, be sure to outline the structure of management at your organization and the hierarchy of various decision-making. If you have a board or plan to have a board, make sure to outline their existing role within the organization. Having an agreed-upon set of rules determining the hierarchy of legal decisions, operation decisions, and final approval rights within the business is key as the company grows and may face big challenges ahead that require a clear, unified plan.
6. Add an Equity and Vesting Section
In early startups, founders may not be taking much or any salary at all. This makes it critical to document and clarifies ownership of the business. The goal of every startup is certainly to grow a successful, thriving business. This could mean aspirations as big as an IPO or major acquisition. Establishing early on what percentage of the company each founder owns as well as the schedule that they will vest their shares, or receive full rights to the shares in the company. Having a unified equity agreement and vesting schedule baked into the Founder’s Agreement is key to outlining the years that each founder is needing to stay with the business to reach their full earning potential. This can help solidify the commitment of each founder to the business as well.
Related Resource: Employee Stock Options Guide for Startups
7. Include a Salary Compensation Report
Even if the salary of each founder is minimal or they forgo a salary as the business starts to save cash, It is helpful to outline a compensation report and even a compensation plan for the founders of the business. A compensation report can outline the initial compensation each founder takes. It can also outline the planned compensation increase for each founder as the profits of the business grow or more funding is granted to the business. Having agreed upon salary compensation documented at the foundation of the company can ensure all founders are aligned on what they are owed and what they are set to earn as the company scales. This will help with tracking financial growth and prevent any major mishaps or founder disagreements about salary and compensation.
8. Dissolution and Termination Clauses
Even though most founders plan to stick with a company they found, that is not always the way things shake out long term. It’s important to think through and document what happens with each founder and their ownership and role with the copy under two unfortunate circumstances.
Dissolution, or the dissolvement of effective closing down of the company, is something that many startups end up having to do if their company does not take off or has a positive growth trajectory. It’s critical to have documentation in the Founder’s Agreement that determines what will happen to any existing profit or patented ideas or technology in a case of dissolution so that all founders are aware and agreed upon that unfortunate outcome – this can save major legal disagreement down the line. Additionally, an agreed-upon termination clause is also a smart piece of information to include in a founder agreement. This can outline the scenarios of a possible founder exit and what will happen to their shares, intellectual intelligence, or technical knowledge in case of a voluntary or involuntary exit. While the reality for founders going into a new business may be with that company indefinitely, things do happen, and planning for possible dissolution and termination can save the team many headaches and heartache at the end of a business or time with a business.
9. Intellectual Property
As part of the termination and dissolution clause, it’s a good idea to highlight all known and defined intellectual property and its ownership within the founder’s agreement. In a situation where a founder exits the business while it is still growing or at dissolution, it needs to be understood where the intellectual property, the ideas, and knowledge that is the foundation of the business, lies while the business is still operating and after. This can help prevent any founder from leaving to start a competitor while the business is operable and ensure that all ideas are documented to the correct owner in perpetuity.
What is the Importance of a Founders Agreement?
A Founders Agreement is extremely important for a number of reasons but foundationally, it provides a unified, agreed-upon set of rules and guidelines for the founding team to align on and build from. A few of the key reasons a Founder Agreement is so important are:
- Identifies each owner’s role – having clarity and unified direction on how each owner of the business (both founders and investors) will play a role in the evolution of the business from the very beginning is critical to the success of the business long term. A founders agreement makes ownership and ownership roles crystal clear.
- Provides structure for resolving issues among founders – Every founding team will have conflicts. Conflict is inevitable when building a business and making tough and risky decisions. Having a Founder Agreement can provide an easy rule book for conflict resolution and managing any issues within the founding team. Because every founder has agreed upon the Founder Agreement, it is a straightforward source of truth when inevitable conflict arises.
- Protects minority owners – Depending on the origins of the founding team and the company idea, ownership of the organization may not be completely even among founders. This makes the Founder Agreement extremely important to minority owners. It provides a clear outline of what they own, what they are entitled to, and the minimum and maximum responsibility they have to the business. This prevents majority owners from gaming the system by taking advantage of the minority owners’ agreed-upon contributions and responsibilities to the business.
- Signals to investors that you have a serious business – A Founder Agreement is a critical contract potential investors will look for when considering your business. Having taken the time to solidify the Founder Agreement is good luck for your business and founding team, showing you have a serious business and have thought through all possible points of conflict, future structure, and ownership balance across the founding team. This helps establish your business as a competent, and well-organized one for potential investors to consider.
Related Resource: Valuing Startups: 10 Popular Methods
How to Create a Founders Agreement
Now that we’ve established the purpose for and critical elements of a Founder’s Agreement, let’s follow a simple process to create one.
1. Select a Template
No need to start from scratch! Plenty of VCs, business schools, and other private companies provide templates for many different documents and contracts typically used when starting a business, including a Founder Agreement. Check out Visible’s template for this here.
2. Knock Out the Easy Sections First
Start with the easy stuff. Your founding team should know your company’s purpose, mission, founder names, and roles and responsibilities. From there, work through the harder organizational and financial details.
3. Thoroughly Work Through the More Challenging Sections
Don’t speed through the complicated aspects of the Founder Agreement. Take as much time as needed to work through financial, organizational, and termination details. Consult attorneys, fellow founders, existing investors, and industry peers as needed to ensure you are following the best possible practices and considering all the necessary elements to complete the more challenging, complex sections. You’ll be thankful you took the time to do these parts in a detailed manner when and if it is ever necessary to consult the founder agreement in a difficult scenario.
4. Consider Hiring a Lawyer if Necessary
Legal battles are never fun. As mentioned above, while you’re taking your time and going over every detail of the complicated parts of the founder’s agreement, consider hiring a lawyer to consult on and help construct the elements with the most liabilities including salary and ownership pieces as well as termination clauses. Get as much legal advice as you might need, and unless you have in-house expertise on your founding team, a lawyer can be especially helpful in outlining the tax section (you certainly don’t want to mess that up at any stage of your business).
5. Seek a Second Opinion from Fellow Entrepreneurs
Founder’s Agreements exist for a reason – they were born out of the mistakes and learnings of previous founders. Consult fellow entrepreneurs who have written and established founders’ agreements in the past. See what worked best for them or what they wish they had included in their founding agreements but did not. No need to reinvent the wheel here, learn from the best in your space.
6. Finalize by Signing Your Founders Agreement
With a lawyer present if needed, set a specific date and time to finalize the signing of your FOunder’s Agreement with all founders present. Ensure all founders have enough time to read, review, and contribute to the said agreement so that on signing day you can celebrate finalizing this foundational piece of legal paperwork and the growth of your company.
Learn More About Founders Agreements and Startup Funding
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