Basics of a co-founder agreement

Basics of a co-founder agreement

A co-founder agreement is also known as a founder agreement, is a contract that governs the professional relationship between the founders of a new business. Each co-founder must devote time and resources into the venture. The co-founders may know each other personally or merely operate professionally; in either case, it is critical to determine certain concerns when co-founders settle on to come together so that there is transparency on what is expected from each other.

What are the important clauses of co-founder agreement?

Business description and goals: It is critical to define the company’s potential venture. It comprises naming the venture, encapsulating the aims, and mentioning about what sort of products/services will be offered by the company. The clause should be precise and not ambiguous. In case a co-founder leaves, the agreement may contain provisions such as prohibiting such co-founder from engaging in ‘competing’ business for a period of time and prohibiting them from using the company’s brand name. As a result, objectively characterising the startup’s businesses is critical.  The co-founder agreement can be entered for a set period of time or a schedule or specific milestones can be specified for determining whether the idea has future business viability.

Financial stake and ownership: Defining current ownership frequently raises the likelihood that the agreement will be unenforceable unless it is registered as a partnership. At this point, parties are left with two options. First option is that they can make the co-agreement founder’s enforceable by registering it with the Registrar of Firms in the state where the business is located. In this case, they can define each co-economic founder’s interest. According to the second option, they may simply declare the future stake that the co-founders will have if they agree to create a formal structure for the business.

Non-disclosure and intellectual property obligations: Intellectual property in all work must be comprehensive and exclusive; utilised for business purposes only. If a co-founder leaves, he/she must waive all rights to any codes, layouts, business strategies, marketing and financial plans, and other information developed for the company. Such content may only be utilised for business purposes. He/she shall also be prohibited from disclosing any information, facts, plans, or insights relevant to the business of any third party without the written approval of the other co-founders.

Mechanism for determining ownership or financial interest: To determine ownership, several methods can be adopted, including equal allocation of interests on the basis of numbers of co-founders, division on the basis of tasks performed by the co-founders, and on the basis of capital contributed.  To determine economic interest, a mix of the said methodologies should be employed. Resultantly, the quantity of capital contributed, the amount of effort expended, the relative worth of the task or responsibility assumed by the co-founder, and guaranteeing some level of parity amongst the different co-founders are important elements in determining the equality split.

Vesting: Co-founders either lose interest or get a better opportunity and willing to exit the business or fired. In such scenario, remaining co-founders need to secure their equity in the venture. For doing so, stakes of the co-founders are vested in the business for a certain time period. In co-founder agreement, vesting of stakes can be included in two ways i.e. milestone vesting and time-based vesting.

Roles & responsibilities: Responsibilities must be shared among the co-founders. It is critical that roles and responsibilities are clearly established for each of the co-founders based on what each of them brings to the table. Operations, sales and marketing, administration, finance, and so on are typical jobs and duties.

The decision-making procedure: How should disagreements be settled? In the event of a corporate debate about business strategy, who gets the final say? Although founders tend to have an inherent knowledge of one another in the early phases, disagreements do develop from time to time. When differences produce friction or take time to settle, the overall operating efficiency suffers. These issues must be addressed through a structured decision-making process. As a result, clause allocating tasks can be included in the agreement, which should be used as a framework for decision making. A voting method among the co-founders could also be included. If a voting method is used, decisions could be made by the majority of the co-founders, with each co-founder’s vote carrying equal weightage, or through a weighted vote, where voting power corresponds to the percentage of the economic stake that each founder owns.

Criteria for performance and termination: Firing is a delicate subject that is difficult to address in writing. Targets are routinely missed in business; however, this does not always result in the dismissal of a co-founder. As a result, firing must be addressed in a broader context. If it left unchecked, the absence of one of the co-founders might lead to slack among the others, as the others will perceive themselves as working extraordinarily hard while one of the co-founders is absent. Co-founders should endeavour to define the conditions under which they all agree that the removal of a founder member is justifiable.

Dispute resolution and conflicts: The co-founders must also define in the agreement the method to be used if there are major disagreements or a breakdown in the founders’ business relationship that cannot be resolved. For the business to survive, the disagreements must be settled swiftly and inexpensively. One must abandon the option of approaching the courts, which has always been available.

Non-compete clause: The agreement should include a provision that prohibits co-founders from continuing work on the same idea if one of them leaves, retires, or is expelled from the company. Strategic differences about the product, on the other hand, can cause co-founders to see multiple products in the same space.

Compensation: Provisions for recovery of costs incurred individually by the co-founders for the business as well as a system for sharing any revenue created, must be incorporated in the agreement.

Mechanism for exit: The agreement should specify how a co-founder may exit the company. This also includes provisions about the removal of a co-founder, such as the circumstances under which a co-founder may be removed and the system to be followed during and after the removal.

To recapitulate, for any entrepreneur, starting a new firm is an exciting time. However, co-founders frequently make the mistake of forgetting key items like entering into an agreement describing each other’s obligations and responsibilities. A co-founder Agreement is a contract between co-founders that specifies details such as initial capital contribution, obligations and responsibilities of each co-founder, and so on. This agreement can also serve as a safeguard in the event of a disagreement, since it may be used to demonstrate what the co-founder agreed to in the first place. A co-founder agreement benefits the founders not only by formalising their partnership, but also by providing direction on how to deal with duties and responsibilities, commitments, and any eventualities that may emerge in the coming times.

-Kiranpreet Kaur

Associate at Aggarwals & Associates, S.A.S. Nagar, Mohali