Why Your Startup Needs a Founders' Agreement + Template 2021
Legal Nodes Team
Have you ever come up with a cool project idea, found a couple of motivated friends, and jumped straight to work? This is how a lot of startups get born.
But it's always worth asking yourself a few questions at the start — how will your business develop further? Who will pay for the initial prototyping and product development? How will you divide company ownership? What happens if one of the founders decides to leave the project?
Those questions are oftentimes brushed under the carpet. However, recent research shows that more than 70% of startups close within the first 20 months and a quarter fails just because of the disagreement within the team.
So why not mitigate things you can at the start to not make the sad statistics. That’s our belief at Legal Nodes and we are happy to share with you top 5 practical tips on what a perfect Founders Agreement should include.
So let’s get started!
P.S. At the end of this article, there is a surprise for you. It may or may not be a free document template but it’s worth checking yourself.
What is a Founders Agreement?
It is an agreement between co-founders or partners who plan to collaborate or are already collaborating on the same project. In this document, the founders outline the details of startup development, who gets what percentage of the company and how each founder will contribute to it (i.e. the rights and responsibilities).
In practice Founders Agreement is often confused with the Shareholders Agreement. The difference is that the first one is signed when the company does not exist yet but the partners have a clear intention to register business and lay down the grounds of future work relationship.
So usually Founders Agreement is used at the early stage of business and is legally binding until the company is registered. After that provisions in the Founders Agreement get reflected in the Shareholders Agreement.
Let’s take an example
There is an e-health startup whose founders have already begun product development. At the same time, the company has not been registered yet and the country of registration has not been determined either. The reason being that most countries require e-health businesses to obtain specific licenses and go through complex bureaucratic procedures.
In this case founders decided to lay out the terms of their cooperation in the Founders Agreement first. It included the roles & responsibilities of each founder as well as a clause stating that they will choose a country and a governing law after additional analysis. The advantage of Founders Agreement is that you have a clear understanding of who is doing what and your startup development plan before going through the formalities of registering a legal entity that might take time.
It is worth clarifying that the Founders Agreement is not always suitable for startups in some areas, so we recommend you to contact a lawyer first. Legal Nodes will be happy to provide assistance with your startup’s legal tasks. You can book a free consultation here as a good starting point.
How to Prepare the Perfect Founders Agreement (5 Practical Tips from the Legal Nodes Team)
1. Indicate what your project is, its goals and key activities
Describe what your startup will do (key activities): developing an application or a website, creating and publishing its own game in the App Store, Google Play or Steam, developing and distributing a hardware product, etc. At this point, be realistic and outline even distant plans — entering foreign markets, creating and registering inventions, etc.
2. Determine the company ownership
In the Founders Agreement, it is important to include a list of founders, indicating who will own which percentage of the future company. Provide brief information on the responsibilities of each founder (such as CEO, CTO, CMO etc.) and KPIs. Startup founders can also highlight that the company's capital should be divided into shares.
3. Define the procedure for accepting new partners into the company and for the existing ones leaving
Building a business and, especially, a startup can be challenging and stressful. Not everyone copes and it's worth agreeing at the start about what happens if a founding member decides to leave the company, how shares will be divided or returned back to the company.
Good leaver / bad leaver provisions are clauses which oblige a shareholder to transfer his/her shares when leaving. The price at which that transfer takes place is determined by whether the partner is a good leaver or a bad one.
So, the good leaving includes permanent incapacity (illness), retirement or a significant change in a company's position, while the bad one could be connected with the violation of the NDA, committing a criminal offense, negligence, dishonesty, failure to fulfill obligations or KPIs, breaking non-compete clause and others.
The usual practice is the following: a good leaver is paid fair market value for his/her shares, and the bad one — the lower or nominal value for the shares.
In another more positive scenario, you would have people joining the company. Here, you need to set how many founders need to agree to accept a new partner to join the company. It can be majority or unanimous. You should also indicate whether a new partner will get the shares and how they will be issued.
4. Indicate how you share startup expenses
Chances are that, at the very beginning, you will be bootstrapping before raising funds. For this period you need to indicate who covers what cost, including salaries, website hosting, MVP development, initial advertising costs and company incorporation costs.
Also you can determine how the funds will be allocated until your startup reaches a certain level of income or turnover, or raise investments. e.g., 50% should be spent on development, 25% on marketing and so on.
5. Don't forget to mention intellectual property, privacy and competition issues
When raising an investment, the founders are commonly asked about intellectual property status. In practice a startup could lose up to a quarter of its value if it turns out that intellectual property was not registered (trademarks or inventions) or it was done incorrectly.
Therefore, it is usually recommended to define in your Founders Agreement that all intellectual property rights to the product including design or any other content, will be transferred to the company when registered. It is also worth indicating that everything created during the course of any of your employees/contractors automatically belongs to your business and not the individuals. If you are creating an innovative hardware product, you could additionally indicate the obligation to file a patent application.
In addition, do not forget to mention that all your business information is confidential and cannot be disclosed as long as such a startup exists. Although for these purposes it is usually recommended to sign additional NDAs with partners.
You can also clarify that after leaving the company, the partners are prohibited to collaborate with competitors and hold C-level positions in their companies (so called non-compete clause).
Founders Agreement is one of the key documents for a startup as it lays out the fundamental points of your partnership and allows you to discuss all the important issues before you dive into the project.
We recommend using the above structure when it comes to drafting your own Founders Agreement as it is based on the best practices.
However, we understand that drafting from scratch may be a daunting task. So, Legal Nodes has prepared a free template! All you have to do is leave an email and get it delivered straight to your inbox.
If you would like to receive support with customising Founders Agreement or any other startup documents — Legal Nodes will be happy to provide assistance. You can book a free consultation here as a good starting point.
Hope you found this article useful! Let us know at email@example.com
Leave your email address to receive a free Founders Agreement template:
By submitting your email address, you agree to receive personalized emails and promotional materials from us.