Going into a startup, co-founders are often excited, motivated, and ready to tackle whatever might come. But as time wears on and struggles arise, it is easy to lose zeal. Beginning a new business involves many risks, and disagreements can creep in under the stress of financial strain and exhaustion. At Calkins Law Firm we were recently approached by a prospective client who experienced this situation firsthand. He had been ejected from the startup he co-founded, and his story reminded us of the importance of a co-founders' agreement.
Co-founders' agreements are complex documents to draft. After all, who could possibly know all the twists and turns that a new business's path might take? All parties involved are agreeing to a lot of unknowns and what-ifs when they come together to create a co-founders' agreement. But this contract is a vital element for every startup. There are many reasons why a co-founders' agreement is so vital, but here we will discuss exactly what it is and which parts co-founders should be especially aware of.
As a general note, a co-founders' agreement should really be drafted and agreed to in the early days of a startup, before things get off the ground. We will be the first to recognize the complexity of drafting such an agreement, and for many reasons a co-founders' agreement should be handled by an experienced practitioner.
What is a Co-Founders' Agreement?
Oftentimes, two or more people come together to apportion a startup. A co-founders' agreement is a legal document which specifies the terms and conditions between these co-founders' and it basically lays out how the business will be operated. A co-founders' agreement is just one of many formalities that need to be completed while launching a startup, but it should never be overlooked as it provides a guide for day-to-day activity and recourse should snags or roadblocks develop.
The co-founders' agreement is a legally binding, printed and signed contract and will act as a baseline for how relationships and roles will work in the future. This contract is important to have, regardless of the type of business entity or structure being created. With a co-founders' agreement in place a system of accountability is created and smooth business functioning is more likely.
Key Provisions of a Co-Founders' Agreement
The co-founders' agreement is unique to the company at hand, and must be based on the startup's specific line of business. It breaks down liabilities and responsibilities, and provides an insurance of sorts should things go awry. With a co-founders' agreement in hand, owners are protected and can send a signal to investors that they have a serious business worth getting behind.
Because a co-founders' agreement is so pivotal to smooth functioning and peace of mind, it demands accuracy. Consulting an experienced lawyer or firm to help in drafting the agreement is the best course. This is not a document that co-founders can afford to make mistakes on.
These elements are essential to any co-founders' agreement:
Co-founders' names. The names of both the business and owners must be clearly specified.
Contract validity. A time frame for how long the co-founders' agreement will remain valid.
Company goals. It is best to state these upfront: the aim of the company, what products to offer, and how the business will present itself to consumers, competitors, and employees. These predictions are not legally binding and can shift as the business evolves.
Details of capital. The agreement should specify each co-founder and/or investor's contribution and the basis of contribution, such as debt, equity loan, etc.
Ownership. Mention the following details for each co-founder: number of shares owned; total amount of capital invested; voting rights; and division of profits.
Roles and responsibilities. These vary based on individual skills and capabilities and should be described and outlined for each co-founder.
Compensation. Co-founders must declare if and when they will take a salary or other form of compensation. Reimbursement of expenses incurred by the individual co-founder must also be decided and enumerated.
Exit procedure. Mention the circumstances of exit, such as underperformance and being asked to leave the company, or termination of employment. Make provisions for remaining co-founders' purchase shares.
Business dissolution. Lay down the rights and liabilities of the co-founders, and how the assets and liabilities of the business will be distributed in case of the winding up of business.
Dispute resolution. Set out the process of how differences will be resolved through a series of steps, such as having an informal meeting, mediation, or an alternative dispute resolution process.
Besides the above list, other miscellaneous provisions are often included. Some of these could be the assignment of intellectual property rights, a confidentiality or non-compete clause, vesting of shares, equity breakdown, and more. And though this document is key to an organized approach and is legally binding, provisions can be included that allow for future changes if co-founders feel the need to change aspects of their business.
DIY or Professional?
Because a co-founders' agreement is a complex legal document, it could prove difficult for an individual to draft one independently. With everything else that is going on when forming a business, it is often best to leave this task to a professional. An experienced and business-savvy lawyer can help co-founders to better understand how to draft a co-founders' agreement, give pointers about which provisions to include, and identify scenarios to anticipate and prepare for.
Experienced Experts, Trustworthy Advice
When preparing to launch into uncharted business territory, you need any and all available support. A co-founders' agreement is vital because you cannot predict what the future holds. Thankfully, you can control the present. So take time now, while your ideas are in their infancy, to meet with your co-founders and decide on some business parameters.
At Calkins Law Firm our team has deep business and legal experience and has seen the real-world consequences of businesses that chose not to draft a co-founders' agreement. We can testify that things go much smoother when planned for. Reach out and learn how our skilled team can help you to put your best foot forward in your new business venture. Here's to you and your dreams!