Legal, Resources|June 29, 2011 2:30 am

Essential Elements of a Founders’ Agreement

Often one starts a venture with another person, who usually is a friend/family member. While there is a lot of debate whether starting a business with a friend is a good idea, we look at another important topic that one should carefully examine i.e. Founders’ Agreement. Whenever you decide to start a business with one or more people (co-founders), it is important to make an agreement that details some important aspects of running the business in the long term. Having a discussion about a founders’ agreement is not only healthy but also prevents any misunderstanding amongst the founders later. We will touch upon some of the essential elements that must form a part of a founders’ agreement.


Shareholding structure and investment

It is important to discuss the shareholding structure of your company. In case of a partnership firm, the profit sharing ratio. Who will own how much equity depends on various factors including capital investment, intangible assets like value, experience. Someone who is contributing more should be entitled to more equity. Contribution could be a combination of money, work, business development etc.


Roles and Responsibilities

Many startups fail because the co-founders are not clear who is responsible for which activity. A task which is owned by everyone belongs to none. Sure, as a startup, you will have lot of things to work on and many of such activities may just pop-up at a later stage. However, it is important to divide roles and responsibilities at the top level. Who will be involved in product development? Who will communicate with the investors? Who will handle marketing/branding/sales? Who handles operations/legal/finance responsibilities?


Salary

Founder salary can be a touchy topic but it is important to address this upfront. Before working on your company business plan, work on your life business plan. Where do you want to see yourself in next 10 years? Would you be OK having a small car when all your friends own big cars? How will you manage your family expectations both in terms of time and money? Be clear about these things before you start the salary discussion with your co-founding team. Initially most startups will not be able to afford a salary for the working founders. However, work out the compensation structure in advance. How much sweat equity does each working founder gets? How much salary do you get when the cash flow gets positive or when the business becomes profitable? A lot will also depend on your roles and responsibilities. Also be prepared to give some of your key employees a larger pay package than what you make.


Exit Strategy

While many founders never think about exiting a business, it is important to plan for such an eventuality. Exiting a business could be for various reasons both positive and negative. If one or more founders want to leave the company, what happens to their equity? What about the money that they have invested? Can they sell their equity to an outsider? What is a fair value in case one of the founders want to buy out the exiting partners?


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  • Exit strategy is one of the key points of any founders’ agreement. One must also discuss other key areas of the shareholders’ agreement including drag along, tag along, first right of refusal etc.