What is a founders’ agreement?
A founders’ agreement is a contract between the co-founders of a company. It essentially sets out the ownership, duties, responsibilities, and the initial investment of each founder. It is advisable to enter into such an agreement during the incorporation stage of the enterprise. This would ensure that the roles of each founder are clearly laid-out.
Why do you need such an agreement?
Perhaps the most important reason for entering into a Founders’ contract is that it avoids any future ambiguity that might arise with respect to the enterprise. Founders’ Agreement sets the expectations and goals of the founders and assigns each a specific role and responsibility to each founder. It identifies possible hurdles and provides precautionary measures. Keeping in mind the above reasons, entering into a formal, written, and legally enforceable agreement is advisable.
Before entering into a founders’ agreement, certain questions need to be addressed and answered by the founders. The co-founders must engage in honest discussions about issues like ownership, title, compensation, the board of directors, etc.
For arriving at a detailed and conclusive answer in respect of such questions, it’s helpful to examine the components of a founders’ agreement.
What are the essentials of a founders’ agreement?
Some important clauses and components of a founders’ agreement are discussed below:
Apart from the name of the founders and the enterprise, it is advisable to define the potential of the business venture with utmost clarity. This should be done by way of clearly laid out terms defining the vision, goals and proposed milestones of the business.
This clause (or clauses) should state the initial investment made by each founder, as well as any additional capital contributions that may be needed in the future from the founders for expansion and operational needs.
Ownership clause deals with equity held by each founder, either by percentage, or the number of shares held. The contribution provided and the role played by each co-founder helps determine his share in equity.
- Roles and responsibilities
This clause is crucial to pre-empt any ambiguity by clearly specifying the role of each founder. Further, every co-founder owes a certain duty and responsibility to each co-founder as well as the enterprise; and the same must be accounted for.
Roles and Responsibilities clause will also play a significant role in determining the decision-making power of each founder, as well as possible future relations with the Board of Directors.
The agreement should also specify the amount compensation provided to and/or salary drawn by each co-founder, as well as the manner of reimbursement of expenses.
- Exit of founders
Although this is a situation that every startup would want to avoid, in order to prevent any conflict in the future, an exit clause must form part of a founders’ agreement. There must be a provision for the case(s) in which a co-founder may choose to leave the enterprise or be removed from the company. Reasons for the same may vary and may include reasons of death and illness. Thus, it will prove to be advantageous to specify a procedure governing every conceivable situation.
This is an essential clause with respect to the possibility of winding-up and liquidation of the enterprise. The manner of distribution of money and other resources amongst the founders in the event of liquidation must be provided.
- Dispute resolution
It is always helpful to create a mechanism to provide for the resolution of any disputes that might arise in the future.
Clauses specifying the manner of resolution of certain disputes may prove to be of aid if the founders wish to avoid a court case to the best possible extent.
- Miscellaneous provisions
Provisions like non-compete clauses, assignment of Intellectual Property rights, loans from founders, severability, etc., usually feature in such contracts. A non-compete clause is meant to prevent a co-founder from quitting and starting a similar business in the future. If the company has availed any loan from the founders, the manner of repayment of loan and payment of interest on the loan must be defined. To avoid future disputes, intellectual property rights of a business should be jointly assigned in the name of all the co-founders. Not only does it serve as protection against disputes, it also serves as the acknowledgment of the wit and effort of each founder that goes into the business.
A severability clause states that the terms of a contract are severable, that is, detachable from each other. Incorporating a severability clause into the agreement helps because even if some terms of a contract are rendered invalid due to any reason, it does not make the entire contract invalid.
A formalized and written founders’ agreement is always better than an oral contract. Further, a written contract should be drafted with the aid and assistance of a legal professional so as to create a watertight agreement without any loopholes that can be exploited.
Exit of the Founder
In early-stage companies, intellectual property (IP) could be the main stock in trade and therefore it is essential to establish that the company is the owner of the IP. The presence of an employment agreement or founders’ agreement makes this process simpler, as they typically contain clauses on ownership and assignment of the IP in the favor of the company, by the founders. However, in the absence of a clear contractual assignment, it becomes essential during a separation event, to get all IP assigned in favor of the company.
If the exiting co-founder is a member of the board of directors of a company also, the separation terms should address the issue of his/her resignation and filing of such resignation within 30 days with the registrar of companies having jurisdiction. The continuing founder shall ensure that there continues to be at least 2 (two) shareholders and 2 (two) directors in the company, even after the separation, in compliance with the provisions of the Companies Act, 2013.
During separation, it is important to take note of the stock in trade, books of accounts, statutory and contractual dues, pending litigations, indemnification obligations under any existing agreements and other financials of the Company. The exiting co-founder may be held liable for any and all statutory and contractual dues, especially for any defaults of the company during his/her tenure of association with the company. In instances such as fraud, wilful misrepresentation etc. the exiting co-founder may also be held personally liable for any damage, loss caused to the company (any existing shareholders’ agreement must also be evaluated in this regard).
Each separation is unique in its own way and the dynamics vary depending on the relationship between the parties, many times they are just friends, family or ex-colleagues. In addition to above, the other material issues for consideration could be:-
- Non-disparagement:This obligation is generally mutual in nature. Instances of disparagement may lead to bad name and reputation of all parties involved in the separation.
- Non-compete, non-solicit:Typically, these flow from employment agreements/founders’ agreement, if executed.
- Confidentiality:The exiting co-founder should be contractually restricted from disclosing any confidential information obtained by such co-founder during the course of his/her association with the Company. Any such disclosure of confidential information may lead to irreparable harm to the business of the Company.
- Branding:The exiting co-founder post such exit, should not brand himself/herself as being associated with the company. The company should always intimate other parties working with the company and revise (to the extent practicable) all agreement, commercials, vender contracts and any other such document where the exiting co-founder has been a party in his capacity as a founder.
- If an exiting co-founder retains equity in the company, post-exit;
- The duration of non-compete, non-solicit in some instances should be linked to shareholding in the Company.
- There should be a power of attorney in favor of one or more of the continuing founders, for ease of operational matters.
- There should be transfer restrictions and provisions for treatment of equity (especially in case of an exit event for the company or a drag situation)