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Why you need to have a founders’ agreement in place

Updated: Jun 1, 2022

One business risk many startups overlook is the relationship between cofounder(s). They assume formal agreements are unnecessary. Big mistake. I wrote a post last year on what to do after a cofounder exits. This time I’d like to focus on how to set things up correctly at the beginning of your relationship so that you are protected when unexpected things, whether good or bad, happen. Remember, many things can happen in the highs and lows of the exciting startup life.

Founders’ agreements are an absolutely necessary piece of startup infrastructure. They help provide the foundation for a successful business by outlining expectations, guiding decision-making, and reducing risk. They also give investors comfort that they are less likely to be caught up in a messy dispute between founders.

Here’s what a good founders’ agreements should include:

Outline responsibilities and decision-making process

There are no guarantees in business or life, but one way to reduce the chance for major conflict between founders is to clearly define roles and responsibilities. For instance, make one founder point person for general strategy and business development and put the other in charge of operations. Agreeing on these ahead of time and writing them down is key. You should also spell out who will make the ultimate decisions and what you will do in case of disagreements.

Equity Ownership

It’s rare that founders contribute equally to the business: either in terms of time or finances. Agree on a split that takes your relative contributions into account as well as how you expect them to evolve over time. The best agreements include multi-year vesting, so that founders’ financial success is aligned with the company’s.

Exit Strategy

Make sure you and your cofounders are aligned on vision, objectives, and exit strategy. And do this at the beginning — before you start up. Your goals for exit will profoundly impact how you set up and operate your business, how you make financial management decisions, and how you build your team. Differences of opinion are inevitable, but you and your cofounders must be on the same page when it comes to your overall goals.

Founder Departures

In the early days, it can seem like your relationship will last forever. That’s usually not the case. Be clear about how you’ll unwind the relationship if either of you wants out. What you want and need to avoid is having someone who’s no longer involved in the company walking away with a chunk of shares or veto power over key decisions. You also don’t need the distraction of a lengthy negotiation over equity and payouts, or worse, legal action over who gets what.

Ownership of Intellectual Property

Founders’ agreements should explicitly assign all IP developed in connection with the business to the company. That prevents your cofounder from seriously handicapping your startup by taking mission critical technology with him or her if the two of you decide to part ways. Most investors, and certainly any acquirer, will require that you demonstrate that you have safeguarded your IP.  Whether or not that’s the case though, you should always make sure you have a strategy that includes a plan for protecting your IP.

Sales/Mergers/Material Transactions

What if you get an unexpected offer to sell your business? Thinking through and agreeing in advance on your exit strategy gives you a framework for evaluating opportunities, whatever they might be. Make sure your agreement addresses accelerated vesting, rights of first refusal, and succession.

Company Dissolution

What happens if you need to shut down the company? Outline how you will manage the sale of company assets and how you will share proceeds.

While you can easily find template founders’ agreements, make sure you have an attorney review yours before you sign on. It might seem like an unnecessary expense, but believe me, getting it right initially and catching any omissions or problematic ambiguities will ultimately be worth every penny.

Guest blogger David Ehrenberg is the founder and CEO of Early Growth Financial Services, an outsourced financial services firm that provides early-stage companies with accounting, finance, tax, valuation, and corporate governance services and support. He’s a financial expert and startup mentor, whose passion is helping businesses focus on what they do best. Follow David @EarlyGrowthFS.


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