You and your friend have co-founded a SAAS company. While you are a techie, your friend is not and is in it only for the title of an entrepreneur. However, both have invested equal amounts and hold 50% shareholding in the company. As entrepreneurs, you have also discussed the vision, roles and responsibilities and other terms on how to take the company forward in length, but have not captured this in writing. With time, your co-founder has other plans and chooses to exit the company.
Given this scenario, do you think it is fair that your co-founder gets to enjoy all the benefits that come with being a majority stakeholder in the company; to have him influence the company’s decisions and change the course of the game even when he is no longer contributing to the company. How should one deal with such scenarios? What should be the next course of action?
Such hassles can be avoided if there is an agreement. Not a verbal agreement but an agreement in writing. This is where the founders’ agreement comes in.
What is a founders’ agreement?
A founders’ agreement is a contract between the founders of a company. The main purpose of the agreement is to align the interests of the founders and bring all the founders on the same page.
What goes into a Founders’ Agreement?
1. Founder Names: Many times, the terms founder and founding team are misunderstood. Founders are individuals who start the company and usually bring in the initial capital. The founders’ agreement is signed only by the founders of the company.
2. Objectives of the company: The goals and objectives (including target industry/market, target customers etc.) for which the company was set up must be clearly defined along with the timeline to achieve each. This will help focus all energy towards a common goal eliminating confusions.
3. Governance and Decision Making: The management structure must be set at the beginning. Kicking the can down the road and not having clarity regarding who is on the Board and in charge of leadership and decision making can turn problematic. Not every founder needs to be on the Board. Ultimately, companies can appoint a CEO to take calls.
4. Roles and Responsibilities: Unlike an enterprise, founders need to wear multiple hats. The agreement must define the key roles of each founder and the compensation payable if any.
5. Equity: Since equity is extremely valuable, any allocation of equity between founders must be clearly captured. A good practice to have is leaving some equity in a “Founder pool” from which equity can be allocated a few years down the line. Allocation can be based on – (a) seniority and experience, (b) roles and responsibility, (c) what one is leaving behind to join or extent of risk being taken, and (d) cash being contributed.
6. Dispute Resolution: It’s worth nominating an arbitrator in advance and an alternate arbitrator. Considering mediation as a process for disputes helps things from getting escalated and becoming nasty.
7. Treatment of additional expenses of the company: Building a company is accompanied with a series of expenses. These expenses mostly include legal, fundraising, research and technology and other operational costs that are often met by the founders. To avoid any large disparity in the amount contributed, the agreement must clearly capture the procedure on how expenses are recorded and maintained along with the ratio in which the costs will be shared between the founders.
8. Exit formalities of a Founder: A founder’s exit has serious repercussions on the company. A founder’s exit can be voluntary or involuntary . Since a founder’s exit is a huge deal, the settlement process must be clearly marked out. Typical exit terms for founders are as follows:
- If the founder leaves the company voluntarily, then any unvested shares in the hands of the exiting founder will be purchased by the company or transferred to the remaining founders.
- In a case where the founder is terminated from employment due to breach of contract or any material misconduct, all shares held by the founder are either bought back by the company or transferred to the remaining founders. In addition to this, provisions on settlement of the exiting founder’s accounts and terms on delegation of responsibilities must be mentioned to ease the change in the operational and management structure.
9. Winding up the company: Winding up the activities of the company is a huge decision that requires the unanimous consent of all the founders. Clear guidelines on how the entire business will be closed on the legal front must be captured. All provisions regarding settlement of accounts, debt settlement and asset allocation have to be captured in detail for the easy exit of the company from the market.
10. Death or permanent disability of a Founder: In such a scenario, a common practice is to vest a portion of the founder’s shares and then issue it to the founder’s nominee or legal heir. The unvested shares are offered to the remaining founders in proportion to their current shareholding. These provisions must be captured in the agreement.
11. Boiler-plate Items: These are straight-forward items – (a) simple employment contracts, that include IP ownership clauses; (b) employment commitments; (c) confidentiality; (d) conflict of interest, non-compete and non-solicitation, (e) jurisdiction; (f) termination etc.
A clear and binding agreement outlining the roles and responsibilities of each founder, will ensure that everyone is on the same page and that the interests of all stakeholders are protected. A founders agreement is like a blueprint for your business, a guiding principle to refer to when things inevitably change, ensuring that everyone’s interests are taken into account, and that fairness prevails.