Why Founder’s Agreement is a Must for Start-up?

There’s a famous story tale about the incubation of Facebook which inspired the movie ‘The Social Network’. It provides an eye-opening account of the importance of the founder’s agreement wherein Winklevoss twin brothers approached Zuckerberg with their brainchild ‘ConnectU’ for finishing coding with just a verbal contract in place stating the payment of fees for the job done along with stakeholder share.

They Zuckerberg stole their idea and built his Facebook Empire, from their idea for which despite the long-drawn lawsuit, they were compensated for a meager $65 million which is incomparable to what Facebook yields for Zuckerberg. Now here’s a catch. Had they signed a written founder’s agreement, they won’t have had to settle for pennies on dollars.

Thus, to avoid having to reach the realization of faltering on promises on the part of either partner for not holding up their end of the bargain be that through unethical ways of conducting business or their efforts towards the company, the direction and future course of the organization or the developing the greed on the go to suck more than the other partners and many more contingencies, right from the age of incubation should the founding partners sign the founder’s agreement.

In absence of a founder’s agreement, running just on the word of mouth entails a potential for the treacherous journey ahead, no matter how good the relation or kinship among the partners, there’s always a looming risk that can turn around the lives forever.

Imagine, how things would’ve been had the Winklevoss twins had been placed in a founder’s agreement, how different the face of social media could’ve been!

Who needs with founder’s agreement?

Every firm has a point where it takes off. The period of incubation is when the basic ideology in every aspect is laid down. In order to take charge and avoid any contingencies in the future, a founder’s agreement is almost essential for small firms and start-ups. Empirically, disputes among founders have been listed as a major source of the downfall of start-ups because almost all the incubations in start-ups, however big or small they may be, have scope for some degree of conflicts among the partners.

In some cases, one partner tries to extract more value than deemed for each of the co-partners. In other cases, it may be differences in the concocted direction they wish the firm to take. All these can be avoided by having a founder’s agreement in place.

What is a founder’s agreement?

A Founder Agreement is a legal contract between partners and founders of the firm defining definite duties, roles shareholdings, exit options that is set in place to protect the interests of all partners with the aim to prevent any conflicts in the future.

A founder’s agreement lays down guidelines that define how to deal with conflicts or any changes in the future like the addition of a new member, the exit of an older partner, resolution of conflicts of interest, how to go about expansion and undertaking new investments and ventures and also deals with stakeholders’ concerns.

Basic elements of a founders’ agreement

  • Personal details


Under this section of the founder’s agreement, we jot down all the personal details of the founders which are inclusive of their roles and responsibilities in the venture. Besides this, we have other details about the firms like company name and the registered office of the company which is required to be included.

  • Ownership structure and equity breakdown


Under this segment of the founder’s agreement, we determine the status and structure held in regard to the owner which determines the percentage owned by each partner or co-founders. And if the venture is an LLC, the percentage of interest of management-owned by each member.

For this, it is imperative to determine whether each member plays an active management role or whether they’re just owners in an economic sense. Besides, equity is one of the most expensive assets that should be distributed amongst partners on the basis of the proportion they’re bringing in for the company in terms of money, resources, time invested, investors, etc.

  • The non-compete and confidentiality clause


The founders always have access to confidential information and thus, trust among the core team is imperative. For example, in the future, if a member wishes to leave, they may use their leverage to share any critical ideas or confidential information with competitors for personal gains.

Thus, a founder’s agreement should lay down guidelines for a binding time in case any partner wishes to part. Also, a provision is also laid down for the parting members to not join the competition, engage in a similar business, or attempt to take away with them clients, vendors, or suppliers.

  • Powers for making decisions


For running any venture, very difficult decisions have to be dealt with. However, how do we decide how to make such calls or who governs the decision-making procedure while maintaining a balance? It is always important to not encounter decision paralysis by letting one entity hold unchecked power over all aspects of the company from equity-related decisions to staffing decisions and new investments.

A founder’s agreement can help to have a clear direction and guidelines for dealing in several aspects as a founder’s agreement and clearly states how the division of areas goes about for ownership decisions, marketing strategies, product and business development, etc. This may give a person clear sole jurisdiction of one or more areas but prevents autonomous decision making by an individual which may entail critical to the growth and development of the firm.

  • The vesting schedule for the long run


How to deal if a founder or partner underperforms after receiving the equity or wants to leave altogether in some time? The founder’s agreement helps to deal with issues like who gets to keep the shares or whether leaving party should surrender it, how to go about distribution in case of spare shares and what to do in case a new addition is made to the company.

By stating the vesting schedule in the founder’s agreement, besides dealing with the current issues, any future contingencies of nature can be avoided especially when funds are raised externally and need modification in that case.

  • Remuneration, compensation, disputes, and resolution


We need to compensate every member for the time and effort they invest into the venture. Similarly, we need to go about the remuneration and criteria descriptions for the same. A founder’s agreement is immensely helpful in laying down the criteria for these besides the resolution of any conflicts or disputes of any kind arising out of disagreements that are a part of the functioning of any company.

  • Exit and winding up


Any of the co-founders may have to leave the company at any point in time due to any reason. To deal with the same in the interest of the company, the founder’s agreement helps immensely in dealing with problems like how to share the profits and liabilities as of then, how to wind up, etc. This clause in the founder’s agreement also helps in tackling the efficiency problems for the underperforming individuals.

Final Words:

One key learning that the Founder Agreement has for sure made us understand is, no matter how small your company size is, how close your relationship with your partner is never confuse or mix your personal equation with the professional one.