A founders’ agreement is a contract between the co-founders of a business that outlines, at an early stage and usually before an operating company is formed, their business relationship and their respective rights and obligations in relation to that business.
We explored the reasons for a founders’ agreement in our previous article, but, what topics are typically covered in a founders’ agreement? In this article, our corporate law experts explore what you might wish to include in the agreement with your co-founders.
Whilst a relatively informal contract, a founders’ agreement typically starts with business basics, including:
- Identifying you and your co-founders and considering whether any other person, for example a family member or third party who perform a role for the business, should be a party to the agreement;
- Describing the nature of the business in terms of its product or service, where it operates by sector and geography, business goals and how success will be measured in the short term and what that will then mean for the business in the future;
- Deciding on a name, logo and if appropriate trade mark, outlining the process for acquiring any domain names;
- Determining the length of the agreement, how to make changes to it and what events will lead to its termination;
- Describing what to do if one of you and/or your co-founders becomes ill, disabled or wants to leave, or if any one of you is under-performing.
Assets and business ownership
One of the critical areas of a founders’ agreement is to detail which of the founders brings what to the business, how that translates into ownership of the business and what happens to the asset if that person leaves.
There are a variety of assets that founders bring to a business, including:
- Ideas, research and prototypes, which may or may not be covered by intellectual property rights (IPR);
- Cash investments;
- Physical assets, such as property or equipment;
- Networks and potential customers;
A founders’ agreement will detail how these assets will transfer into assets of the operating company once it is formed, since ownership of them by the operating company will be crucial to its success and ability to attract further investment.
Equally, a founder may wish to retain ownership of certain intellectual property rights and only transfer ownership of them to the operating company at a later stage in the company’s development, licensing them in the meantime.
Business roles, recruitment and decision making
A founders agreement may also set out who will perform each role and how business decisions will be made, including any matters that may require consent of all or most of the founders. This will avoid protracted disagreements and deadlock.
Role allocation is important to ensure that the business runs smoothly and that each founder is clear as to their respective remits. This also applies to recruitment. The founders’ agreement is an ideal place to set out recruitment goals, salary budgets and key hires although a distinct operating entity (company or partnership) will need to be in place prior to taking on employees.
Founder salaries, early business profits and investment
A founder may draw a salary from a business if they spend a large proportion of their time working in the business. The founders’ agreement can prescribe for this and also for the reinvestment, division and distribution of any early profits generated by the business.
A founders’ agreement can also set out an agreed approach to the sourcing of investment for the fledgling business, including the allocation of any investment shares. The fact that a founders’ agreement exists often makes investment in the business more appealing as an investor can have confidence that many of the tricky issues that accompany business relationships have been considered and dealt with.
As with every relationship, the founder relationship can break down.
At a minimum a founders’ agreement should cover the exit of any of the founders. These exit provisions should include:
- What happens to any assets the exiting founder brought into the business;
- What happens to any shares in the operating company that the exiting founder may have in lieu of assets;
- What happens to the business without the exiting founder;
- If the business continues, what happens to the profits that the business might generate going forward;
- Excluding the exiting founder from decision-making processes;
- What happens to any intellectual property rights that the exiting founder might still hold and that is essential to the operation of the business?
Confidentiality and non compete
It goes without saying that founders should maintain the confidentiality of the business, its secrets, proprietary data, customers, know how and employees.
This confidentiality should continue post any founder exit. Equally in these circumstances, it is quite typical for founders to agree to time limited non compete clauses, so that the exiting founder does not set up a competing business or work for a competitor immediately upon exiting the business.
What happens once you set up a limited company or partnership?
Once you decide to go down the route of a limited company or partnership for your business, then your founders agreement will typically be replaced with a shareholders agreement (limited company) or partnership agreement (partnership).
A founders’ agreement may shorten the time taken to agree these subsequent agreements, as they will cover many of the same topics but in greater depth.
If you are considering co-founding a business or are in the process of doing so, then please contact our corporate law experts who can assist you in navigating some of the above issues so that your business gets off to a smooth start.