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The 1st thing startups should do is to put in place a founders' agreement.

Putting in place a short, simple agreement between the founders (also known as "founders' agreement") of any startup right from the first day (or, at least, in this initial months) prevents future heartburn. Even if it is an informal set of terms and conditions, it helps to have it written down over an email or paper - this gives a reference point to all stakeholders. At the end of the day, it is a commercial venture that's being undertaken and would result in assets and/or liabilities (in simpler words, profit and / or loss) being created. It is important that these aspects do not come in the way of or spoil relationships, the collective force of which is running the startup and holds the potential of making it successful.


Prominent reasons for founder disputes

Key ingredients of the agreement


The most prominent cause of startup failure is conflict between founders. Every conflict is undesirable, yet conflicts are inevitable. When individuals with diverse backgrounds, visions, and aspirations come together to build a company, disagreements are bound to arise. However, what separates successful startups from those that falter is the presence of a solid foundation—a founders’ agreement. A founders’ agreement serves as a vital framework for resolving disputes, clarifying roles and responsibilities, and establishing a shared vision among the founding team.


In this article, we will delve into the importance of a founders’ agreement and explore how it can mitigate conflicts, enhance collaboration, and ultimately pave the way for the success of a startup venture.


What is a Founders' Agreement?


A founders' agreement is a crucial document (generally laid down in the form of a legal agreement), that outlines the rights, responsibilities, and obligations of the founders of a startup. It serves as a legal contract that establishes a framework for decision-making, ownership, and dispute resolution among the founders. The importance of a founders' agreement cannot be overstated, especially in the early stages of a startup, as it helps mitigate potential conflicts and sets the foundation for a successful and harmonious business venture.


When to do it?


Ideally, the right time would be at the very start of things. When founders have joined hands and come together, they should put some basic understanding into tangible writing. Without getting into hassles (and also because the plan or product or way forward would be far from having shape), at the least the founders should write down over an email what they've agreed upon this far.


Before the formation of any entity (such as a private limited company), the agreement should desirably be in place. One should not go by the plain-appearance clauses in the memorandum or articles of association, because once you sign on them, they (generally) constitute the first understanding between the promoters and the very company that they’re forming – this is removed from reality because the first understanding would not have actually been written down.


If neither of the above has been done, the time prescription is – do it at the earliest.


Key ingredients of the Agreement


The agreement process should start with identification of the vision. Though it may not expressly be written into the agreement, it is important that the vision of the company and that of the individual founders are identified, discussed, and aligned before one would sit down to draft the agreement. Vision alignment would help identify and iron out any material differences at the outset. It should not be so that one founder aims at a quick windfall exit at the earliest opportunity, while the other dreams of a long-term steady-growth stint at the venture.


Once this is in place, the regular and objective features of the Agreement would generally cover the following:

Relationship aspects

(or, Agreement clauses)

Questions to ask and answer between the founders

Commitment

  • ​What would be the contribution of each founder?

  • Whether everyone would work full-time or there are some who’d be associated only part-time?

  • What is the capital being contributed by each founder?

  • Are there any intellectual properties in personal names being contributed by anyone?


Ownership

  • ​What is the percentage shareholding of each founder?

  • Is there any vesting plan for such shareholding, linked to a time-period or performance?

  • How would the ownership structure change in case of future investors or other shareholders being roped in?

General management of the business

  • How would decision making happen at the entity?

  • What would the roles and responsibilities of each founder?

  • Would each founder be a director (in case the entity is a company)? If so, what would be the respective executive roles of each director?

  • Would there be other directors? If yes, what would be the reporting and work-allocation structure in the entity?

  • What would be the salary of each founder? How can the salary be changed?

Lock-in and exit

  • For how long (years) would the founders commit and lock-in themselves with the business?

  • What if one founder decides to leave?

  • When can other founder(s) ask or require a founder to leave?

  • What happens to the shares of the leaving founder – does he retain the shares, or the continuing founders have a right to buy him out?

  • How can it be ensured that a leaver, whether a good-leaver or a bad-leaver, does not disparage or harm the business?

  • What would happen in the case of an unfortunate disability or death of a founder?

Closure of the business

  • When to shut down the business or entity, if at all?

  • How would the distribution of the business’s assets take place (including intellectual property) in such a case?

Dispute resolution

  • In case there is a dispute between the founders, what would be the procedure for its internal resolution?

  • How would the dispute be resolved through external intervention (e.g., arbitration)?

Confidentiality, non-compete, and non-solicitation

  • Can the founder(s) collectively or individually found another startup while the present business is continuing?

  • How to ensure that confidentiality of business secrets, information, intellectual property, and other trade related information of the business is respected by each founder?

  • In case of a founder leaving the company, how to ensure that he does not do any business in competition with the present business, and does not harm the present business by soliciting employees or customers?

If professional assistance is unavailable for drafting the agreement, it is still possible to capture the essential elements by documenting them in plain language. While the expertise of advisors and lawyers can provide additional clarity and ensure comprehensive coverage, a simplified agreement can still be effective. By clearly articulating the key terms and expectations, founders can create a tangible agreement that serves as a reference point for their working relationship. A well-drafted founders' agreement, even in plain language, can provide a solid foundation.


Difficult yet worthy conversation!


A founders' agreement is not merely a bureaucratic formality but an indispensable tool for startups. It establishes a solid foundation for collaboration, ownership, and decision-making, ensuring that all founders are on the same page from the very beginning. By clearly defining expectations, obligations, and key aspects such as ownership and intellectual property rights, it minimizes the risk of conflicts and disputes down the line. Moreover, a founders agreement promotes transparency, trust, and accountability among the founding team, enabling them to navigate challenges and make informed decisions together.


While initiating these discussions may be challenging and emotionally difficult, the effort invested in crafting a comprehensive founders' agreement is undoubtedly worthwhile, as it paves the way for long-term success and growth for the startup. By laying the groundwork for a harmonious and well-defined partnership, founders can focus their energy on driving innovation, pursuing opportunities, and achieving their shared vision.


Authored by Amar Gahlot, Advocate. The views expressed are personal and do not constitute legal opinion.

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