Get Partner/Founder Agreements in Place

What if someone wants out of the business a year later, becomes disabled, or dies? If someone leaves for any reason, how will the remaining partners value the company at that time, and how should shares be divided? It’s important to make sure everyone starts the venture on the same page, with their roles set forth and with an agreed-upon framework in place for heated situations likely to come up down the line. Unraveling a knot later can take months, and it often unravels the company and friendships, too.

“If someone leaves for any reason, how will the remaining partners value the company at that time, and how should shares be divided?” 

Why is a Founder’s Agreement Important?

A successful business requires a solid foundation. While there are many elements of this foundation, the founders of the company being on the same page is one of the most fundamental. While it may seem odd to stop to put in place a legal agreement before you have your first customer, or when the business is really small, you would be surprised how much more difficult it can be to create alignment when you are flying the airplane while you are fixing it. If you’re planning to run your business with co-founders, then a founder’s agreement is pretty much the perfect place to start.

What is a Founder’s Agreement?

It is extremely difficult to find the right co-founders for your business. You need to have a similar work ethic and timeline for the investment, your chemistry has to match, and you have to make sound decisions for the company. With multiple founders, a vital document to put in place in connection with the formation of the entity is a founder’s agreement. A founder’s agreement is “a clear agreement between founders on a number of key issues that their business might face.” You can treat it as a baseline for how your co-founder relationships will work, how your company is structured, and everything else we’ll talk about. It’s the ideal place for you and your co-founders to think through any potential problems you or your business might face—and to brainstorm solutions for the future. The goal is to ensure the deal between co-founders is set in stone so everyone can focus on building the business.

Such an agreement will typically address the fundamental issues of the company including:

• Contribution. You should outline what each founder will contribute to the business. In other words, what assets or cash into the business does each founder contribute or invest?
• Roles and Responsibilities. You are going to want to make sure you have a clear understanding around roles and responsibilities up front. It is critical that a co-founding team collaborates and creates an open and shared culture amongst themselves, but that shouldn’t necessarily mean everyone is in charge of everything. Divvying up roles and delineating responsibilities early on lets you avoid confusion and redundancy. Making sure everyone knows what they need to be doing means that you’ll have a less wasteful, more efficient business. The more specific you can get, the clearer it will be. Of course, that doesn’t mean you need to abandon teamwork, transparency, and communication. In fact, by establishing distinct roles and responsibilities, you’re making it as easily understandable as possible who gets the final say on which things, and which other aspects of your business should be determined by consensus. You’re saving time, energy, and emotions by agreeing to these processes early on. Finally, you’re creating a system of accountability—if something doesn’t get done, you know who’s to blame. Likewise, if things doget done, you know who to congratulate! Accountability isn’t just a way to measure whether employees (or co-founders) aren’t working hard enough: it goes both ways. You’ll be able to adjust compensation, or even equity, depending on performance. Doing so will go a long way in helping you minimize growing pains. This part should answer, among other things:
  • What are the roles and responsibilities of the founders?
  • How are key decisions and day-to-day decisions of the business to be made? (majority vote, unanimous vote, or certain decisions solely in the hands of the CEO?)
  • How much time commitment to the business is expected of each founder?
• Compensation. You should define the compensation of each of the founders. It should address, among other things:
  • What salaries (if any), are the founders entitled to?
  • How can that be changed?
  • Does it change if the founder leaves the day to day activities?
• It’s up to you how in-depth you want to go. You can create a thorough compensation plan that accounts for future growth, or you could just deal with present circumstances. Either way, setting a baseline will help you avoid unpleasant surprises.
• Equity Ownership. You’ll need to allocate the ownership of your new enterprise amongst the founding team. While this is a subjective matter and can sometimes be very delicate, it is imperative that you nail down how you will split up the equity between the founding team upfront to make sure there are no misunderstandings or hurt feelings once things get off the ground. Remember that you typically will have 90 percent to play with, as you most likely want to set aside at least a 10 percent option pool for future rank and file hires. Also remember there is no rule that says all of the co-founders will have equal ownership of the new enterprise — and that’s where it gets a little tough. You may have to tell your co-founders they are not your co-equal. But it’s always better to have that conversation on day one and not to move forward with a new enterprise and then get stuck on who owns what. There are multiple ways to split equity:
  • Equally. Some co-founders might just want to split the equity evenly between themselves.
  • According to Role. Others might want to distribute them according to the roles and responsibilities.
  • Contribution. Some allocate more equity to those that contributed more cash to get the business started.
  • Idea Creator. Some allocate more equity to the person who came up with the idea.

There are some terrific templates out there.

• Equity Vesting. Even when you decide on the allocation of equity among founders, this does not mean that this equity is all issued and effective day one. Provisions need to be put in place so that they equity “vests” over a period of time. What that means is that each of the founders must earn their equity by contributing to building value in the enterprise. If co-founders got their shares all at once, there would be nothing stopping them from performing and staying in the business over a business of time. The most common vesting terms are those that occur monthly or quarterly over three or four years. By creating a vesting schedule over multiple years you’re encouraging everyone to earn their keep. Plus, investors will expect a market-typical vesting schedule, and not having one wouldn’t be a great sign. Remember that you’re not doing this just because investors expect it. You are doing it because you will create very significant enterprise risks if one of the members of the founding team picks up and leaves for the beach and you are forced to use dilutive equity to bring on replacement talent; not to mention you don’t want to create any incentives for a free ride. Among other things, this should help you address questions like:
  • Is the percentage ownership subject to vesting based on continued participation in the business?
  • If one founder leaves, does the company or the other founder have the right to buy back that founder’s shares? At what price?
• Not Living up to Expectations. A founders’ agreement should go over the circumstances of termination: what happens when a co-founder has been consistently underperforming, and needs to be let go? These are difficult conversations but protect everyone. They would address topics such as:
  • What if a co-founder is underperforming?
  • What is the process for making that decision? Would it require a “vote” by a third party (such as an advisor)?
  • What if a co-founder just wants to leave?
  • What are the consequences to equity and in particular unvested shares of equity?

Setting up a system to deal with termination will go a long way especially if that termination isn’t a friendly one.

• Intellectual Property.When you and your co-founders begin to iterate on an idea and develop a business plan or begin to build a product or a platform, you are creating intellectual property (IP). IP comes in many forms but make sure that whatever IP is being developed for your new enterprise belongs to the entity and not the individuals behind the development of the IP. That includes your products, recipes, marketing materials, logo, branding, packaging, website, business plan, theme songs, inventions, and more. Needless to say, your intellectual property is important to protect—and the founders’ agreement is a great place to do that. This should address the following:
  • Ownership by Business. Any intellectual property developed for your business goes to the entity itself, not to any particular person. For example, say one of your co-founders comes up with a great new name or technology solution. Unfortunately, too many founders work, iterate and develop an idea or a technology but separate before the IP that has been developed has been assigned from them into the entity, meaning your new enterprise may not have rights to various things that it will need to evolve its business or otherwise raise capital. If your founder’s agreement states that any intellectual property devised for the business is owned by the business and not any co-founder or employee who came up with it, you would be covered. Ideally this would never become a problem, but if someone decided to break away and form a successful competing business—all because of an invention he came up with while working with you – you would be protected.
  • Applies to All. This concept extends to not only your co-founders but all of your employees, consultants and contractors. This usually takes the form of an intellectual property assignment agreement that is executed by everyone that joins the company and in provisions contained in contractor and consultant agreements.
  • What Constitutes Intellectual Property. You need to decide what constitutes intellectual property for your company. Obviously it includes anything co-founders create, relating to the company, during work hours. But what about ideas generated outside the office, such as when someone is on vacation, or a voice recording someone adds to their phone with their “idea”? A broad definition related to the business of the company regardless of time or place can be used, but must be balanced with not discouraging employees to be creative in their own right and for their own interests.
  • Selling Intellectual Property. You must make it clear that when intellectual property is owned by the business, this does not change in the event that the company is bought – especially when some value is put on the intellectual property.
• Non-Compete and Conflicts. You can’t have co-founders do anything during their employment or after employment that competes with the company. Certainly when co-founders are dedicating their entire time to a company that is easier. But what if a co-founder is doing some outside consulting work to make some money? This may also apply to a co-founder owning stock in a competitor. Setting out what founders can and can’t do is important.
• Results in the Case of Fundamental Transactions. Setting out what happens when the company raises significant capital, is acquired or makes an acquisition should also be a part of these agreements.
• Dissolution. We never want to think about the business not making it, but setting out what happens if it does not make it will help if and when the time comes. A good agreement also acts as the company “prenup,” detailing what will happen to the business if you decide to part ways.

We tend to overlook discussing these fundamentals when the entrepreneurial gears are spinning, but writing up a founder’s agreement forces us to address these topics and clear up any mismatched expectations everyone could be bringing to the table. Unfortunately, co-founding a business isn’t too dissimilar from marriage. You can start with all the right intentions and never imagine separating. But it does happen. Plan ahead. Otherwise, you will jeopardize the viability of your new enterprise.

Creating a Founder’s Agreement

Now that you understand the issues that should be addressed as part of a good founder’s agreement, here are the steps you should take to create one.

• Set a Timeline. A founder’s agreement is one of those things that lingers unless you hold yourself accountable to a date.
• Use a Template. There are many templates for founder’s agreements available. There are plenty of templates available online for you to peruse. Choose the one you feel most comfortable with. Remember the template is just a starting point so don’t be concerned about the final language at this point. Here is another.
• Complete The Basics. Fill out the simple stuff including name, company, addresses, etc.
• Discuss the Issues with Your Co-Founders. Try to get aligned on the fact that you agree that this is necessary and will help both of you. Go through one by one the issues – compensation, equity, vesting schedules, roles and responsibilities, termination clauses – and talk it through. This will likely take several rounds of discussion. You want to walk away on the same page on all the major issues. This is easier said than done, but try to reinforce that you are both doing it to benefit everyone including the business.
• Take Your Agreement to an Attorney. Your agreement will give them a good start and experienced attorneys in this area will be able to fill in the blanks. In addition, the attorney can act as a go-between for you and your co-founder if there are issues you can’t resolve. Lawyers aren’t free but they can add a lot of value in getting an agreement in place that everyone supports.
• Review – Separate and Together. The lawyer should prepare a draft agreement for you and your co-founders. You should read it separately and then go through it together to lay out differences and points that need more discussion or clarification.
• Finalize and Sign. Bring your collective comments back to your lawyer and have him prepare a final agreement for review and signature.

The process may vary for you but these steps should help you stay on track to accomplish this important step.