Most people are familiar with the basics of a business plan, yet there is another important legal document every business should have in place: The Founders Agreement.
Don’t be alarmed if you haven’t heard of the Founders Agreement. The average entrepreneur is unaware of this document, and for good reason. Most aspiring business owners are justifiably laser-focused on developing their value offering, bringing it to market, and capturing market share.
We’ve got the inside scoop on everything you need to know about the importance of the Founders Agreement for conducting business as a startup.
What is a Founders Agreement?
The Founders Agreement is a contract that a startup partner presents to additional founders for the startup’s pre-incorporation. The purpose of this contract is to define the individual liabilities, duties, and roles of each partner. Moreover, the Agreement establishes the intellectual property rights of each co-founder.
The Founders’ Agreement is fundamental for organizing and planning the relationship that serves as the foundation of a startup business. Exercise prudence when creating your Founders Agreement, and you’ll generate interest from financiers while simultaneously setting the stage for the success of your enterprise across the long haul. Be aware that even a slight misstep in terms of the legalese used in the Founders’ Agreement has the potential to render the agreement unenforceable or rife with loopholes that give overly litigious parties an opportunity to harm your business’s bottom line.
Common Mistakes to Avoid When Structuring a Founders Agreement
Plenty of entrepreneurs have made the mistake of creating a Founders Agreement without the guidance of a business law attorney. Such a strategy may prevent prospective investors from taking the entrepreneur’s startup seriously. Moreover, the lack of a Founders Agreement has the potential to lead to costly legal conflicts down the line. Keep in mind, the risk of proceeding without a Founders Agreement increases with each passing year as your startup continues to gain momentum, rake in the cash, and become increasingly successful. Lean on an established business law attorney to create your Founders Agreement today so you and your team can proceed into the future with confidence and certainty.
Without a proper Agreement in place, there is high probability that disputes among the business’s founders will lead to confusion regarding responsibilities and roles and potentially internal conflicts. Each founder’s role should be clearly defined to clearly designate responsibilities in the context of conducting business. The Founders Agreement should also fairly split equity to prevent potential resentment that causes internal disharmony.
Another common mistake startup entrepreneurs make is relying on a generic web-based Founders’ Agreement template. Your startup needs the expertise of a proven business law attorney for the creation of a bulletproof Founders Agreement. Such an agreement will be written with strategic language that protects the founders’ financial and legal interests while also being legally binding.
Why Do You Need a Founders’ Agreement?
A Founders Agreement is necessary for several reasons. First, this document provides a blueprint for decision-making in the weeks, months, and years ahead. The Agreement establishes all the pertinent details in relation to the founders’ duties and liabilities. Such terms are necessary for fully defining and aligning expectations. The Founders Agreement ultimately ensures all founders are on the same page in regard to equity, rights, responsibilities, and liabilities.
Founders Agreements also communicate the founders’ shared vision for the enterprise for posterity’s sake. This document is essentially a guide for the formalization of responsibilities as well as the expectations of each individual founder. The best Founders Agreements reflect the dialogue between founders regarding the enterprise’s expectations across the long haul, allowing for cooperation, harmony, and mutual benefit that helps the collective of the startup fulfill its potential in the form of a whole that is greater than the sum of its parts.
What Should Be Included in the Founders Agreement?
Meet with a savvy business law attorney for a thorough review of the most comprehensive Founders Agreements of successful startups, and you will find they share common themes. The best Founders Agreements contain a list of financial commitments and investments ranging from intellectual property to dry powder capital, co-founder investments, and more.
Founders’ Agreements must also contain information pertaining to the rights and rewards of decision-makers, such as which parties sit on the board. Moreover, the specifics of the founders unique roles and responsibilities, including titles, must also be included. In particular, decision rights are of the utmost importance as they name the individual with the final authority for the business and also detail meaningful circumstances.
Fail to establish a clear path for decision-making and conflict will inevitably result. Furthermore, the Founders Agreement must also detail the ensuing course of action in the event of partner disagreement. Comprehensive Founders Agreements also include rewards that detail exactly how much money each co-founder receives in terms of net profit percentage or financial rewards when specific milestones are reached.
The specifics of ownership percentage in the venture are to be detailed in the Founders’ Agreement. The positions of the corporate board must also be well-defined. Specify which founders or other properties represent the business on the board and thoroughly define founders’ observer rights.
Tips for Negotiating the Terms of the Founders’ Agreement
The best Founders’ Agreements are characterized by terms negotiated by a business law attorney. Meet with one of our attorneys, tell us about your startup or other enterprise, and we’ll tailor legal guidance accordingly. Consult with our legal team, and you’ll find there is more to a Founders’ Agreement than merely splitting up capital investments and ownership equity in the enterprise.
Founders’ Agreements rights distribution is a highly complex matter that requires the expertise of a seasoned business law attorney to address the following:
- The issuance of original shares to those who founded the enterprise
- The issuance of shares to new owners
- The incurrence of founder loans, along with subsequent repayment
- Control over the board of directors, including which individuals have the right to sit on the board
- Granting of security interests
- Authority for spending
- Signing of contracts
- Expense incurrence/repayment
- Compensation entitlement
- Subtleties of the language detailing who nominates new board members
Even the details of intellectual property rights are to be strategically negotiated when this critically important legal document is drafted.
How Do You Structure a Founders Agreement?
The subtleties of your Founders Agreement structure are essential for the success of your enterprise across posterity. Overlook even one detail and there is the potential for conflict, legal or otherwise, to take a chunk out of your company’s bottom line, eat away at your personal assets, or even bankrupt the company. Our business law attorneys are here to structure the Founders Agreement to protect your financial and legal interests.
The Founders Agreement should be structured with lucidity, transparency, and rigidity to clearly define all roles and responsibilities, setting the stage for clarity in terms of decision-making in the years ahead. The proper structure provides the transparency necessary to prevent ambiguity that leads to lawsuits and other unnecessary drama. The structure should detail exactly how disagreements will be handled, making it perfectly clear to all parties as to what their ownership stake is, whether they will be on the board, and what their individual powers are.
Everything from ownership share to intellectual property distribution, vesting schedules of shares, and policies that detail how disputes are to be resolved must be clearly defined. Moreover, the Founders Agreement should also include a confidentiality clause or section of non-disclosure that details how trade secrets and intellectual property will be protected for the company’s benefit.
Though no startup founder wants to ponder the idea of the business failing or selling the enterprise, the future is uncertain. Thus, it is financially and legally prudent to craft a Founders Agreement with fully detailed exit terms, liability responsibility, the share of future profits, and the fate of intellectual property in the event of dissolution.
Is a Founders Agreement Legally Binding?
Yes, a Founders Agreement is a legally binding contract that requires review and dated signatures. There is also the potential for the Founders Agreement to be incorporated into the startup’s corporate bylaws. If a conflict or dispute arises between the founders of the business or other relevant parties, the Founders Agreement can be referenced in the ensuing legal discovery process and serve as evidence in a court of law.
Founders Agreement vs. Shareholders Agreement
There are substantive differences between Founders Agreements and Shareholders’ Agreements. Each is a legal document for startups that details the responsibilities and relationships of company shareholders and founders. Founders Agreements are primarily focused on the founders’ responsibilities and rights, detailing the allocation of equity.
Shareholders’ Agreements, however, are legal documents that detail shareholders’ legal obligations, responsibilities, and rights. The typical Shareholders’ Agreement is more extensive and complicated than the typical Founders Agreement. Moreover, Shareholders’ Agreements are written when the startup issues shares to outside investors. This agreement serves as a framework for the shareholders’ relationship with one another while also detailing the rights of investors.
Founders Agreement vs. Operating Agreement
An Operating Agreement is a document created at the time of a business’s formation that covers topics included in the Founders Agreement. Such topics include, but are not limited to, the following:
- The distribution of profits
- A designated course of action when capital is necessary
- Limitations to ownership stake transfers
- Additional relevant considerations
Though Operating Agreements are not required in every state, LLCs that lack such an agreement will be legally bound by the law of the state’s LLC Act.
What is a Founders Stock Purchase Agreement?
Though similar in name, a Founders Stock Purchase Agreement is different from a Founders Agreement. A Founders Stock Purchase Agreement details the company ownership stake in its infancy. It is a legal contract that helps define shareholder stake in the business and the ownership terms and conditions.
Such an agreement is a legal contract as it contains detailed terms that govern the acquisition and sale of stock shares along with the nuances of a vesting schedule. Founders’ Stock Purchase Agreements safeguard equity along with the founders financial investment in the enterprise.
Trusted Attorneys for Creating Your Founders Agreement
The quality of your attorney has the potential to be more important than the quality of your startup’s value offering. A single mistake in your Founders Agreement or other legal contract can upend your enterprise, possibly even leading to bankruptcy.
Our legal team is here to create a legally bulletproof Founders Agreement that protects the time, money, and effort you’ve invested in launching your startup company. Put your trust in our attorneys, and we’ll tailor the language of your company’s Founders Agreement to your individual needs and desires, ultimately safeguarding your financial interest.
Reach out to our law firm today to learn more about how we help entrepreneurs, startups, and other business professionals. You can contact Rapacke Law Group to schedule a no-cost strategy call by dialing 954-951-0154. Our support team is available from Monday through Friday, 9am to 7pm EST. You can also book a free consultation on our website in two easy steps.