Did you just find your perfect partner for your startup idea to life? No matter how confident you are in the relationship, don’t skip the paperwork. Your paperwork should include co-founders agreement.
A co-founders agreement (“Agreement”), a contract executed between the founders of a business, with details for equity contribution, roles and responsibilities, legal contingencies, and aspects of running the company. We, decoded raising funds as a startup in the previous article, here we talk about crucial co-founders contract provisions.
IMPORTANT CLAUSES TO INCLUDE IN FOUNDER’S AGREEMENT
Best to have us do the nuanced effective detailing, legally however when you are speaking without the lawyers, you need to keep the following tucked in a row:
- Distribution of Equity Ownership
- Covenants & Warranties & Obligations
- Intellectual property ownership
- Remuneration & compensation
- Contribution in capital or Sweat Equity & Stock Options
- Decision-making
- Exit options
These smoothen the startup journey and leave you with time and energy to pursue and grow your dream business.
1. Equity Ownership:
This is critical to know with as much clarity as possible at your stage, as to the % of holding against the funds in the startup. This clause tends to become more important when the startup gets to fund raise.
2. Covenants & Warranties & Obligations:
The covenants and warranties and obligations needs to be as detailed as permissible. These are essential factors for the smooth and successful functioning of your startup.
3. Intellectual property (IP) ownership:
Is the startup a new legal entity, or is it changing forms, for instance, converting into an LLP or Private Limited company from sole proprietorship? In any case, the IP identification and the manner of the handling has to be clarified. This will ensure that the use of the IP by the startup is legal and would avoid any possible breach of IP and get included in the Asset side of the business.
4. Remuneration & Compensation:
How is the business going to look at the remuneration and compensation payable to the founders? Remuneration and compensation have nuances which include ratio to investment or time invested. This also ties in with the long term aspirations of each of the founder.
5. Contribution in Capital or Sweat Equity/ Stock Options:
This is tied in with the previous component of remuneration and compensation since there are significant number of modalities and combinations that can be drawn in for this space, some founders bring in speciality which can be rewarded through sweat equity and some find it beneficial to be seen as capital infusers. Co-Founders can use this in an effective way to make fund raising decisions clean and viable. This is also the place and time to structure the ESOP pool of the business and consider the allocation.
6. Decision-making:
Decision-making may be linked to the investment in the startup or can be assigned to an identified personnel alone. The critical part in this remains around day to day operations vis-à-vis long term decisions of the business like dilution of equity, hiring of new management personnel, raising debt, etc.
7. Exit Options:
Exit options require calibration. To avoid dilution by transfer of shares to outsiders, a lock-in mechanism or Right of First Refusal (RoFR) is included. RoFR allows the continuing co-founder to buy out the equity shares of the other co-founder instead of it being sold to an outsider.
One essential aspect, tied to the Exit Option is, non-compete. In most Co-Founder exits it is linked to misuse of confidential information. Negotiating a well negotiated reasonable non-compete clause can be a vital component.
The Termination Clause and Dispute Mechanism form important components which make for good provisioning around conflict management. We recommend a good and reasonable lock-in which is likely to support the business. In case of breach of the Agreement or an irreconcilable dispute, the dispute mechanism clause will kick in.
Arbitration, seems a preferred mechanism, however for Founder’s Agreements we do not believe, it to be the most effective way. It serves better to have a well-developed mediation matrix for disputes.
But what happens during the dispute period?
The business will definitely be impacted because of the dispute; however, having a co-founders agreement with supportive mediation process could ensure a easy and peaceful transition. It may be diligent for Co-Founders to work out the allocation of duties in event of a conflict so that the business is least impacted. The goal of an efficient conflict resolution ensures that the business remains stable during founder exits.
A clear understanding of dispute management aids in taking the business through difficult times.
If your Agreement does not include the point for dispute mechanism, the dispute can then be resolved by referring to a court of law per the contract law prevailing in the jurisdiction of business establishment.
In the upcoming edition, of this start up series, more on Non-Disclosure in Founder’s Agreement.
With the increase in establishing startups and easy exchange of business ideas, Non-Disclosure commitment becomes crucial.
This is only for informational purposes. Nothing contained herein is, purports to be, or is intended as legal advice and you should seek legal advice before you act on any information or view expressed herein. Endeavoured to accurately reflect the subject matter of this alert, without any representation or warranty, express or implied, in any manner whatsoever in connection with the contents of this. This isn’t an attempt to solicit business in any manner.