Building a high-growth tech startup is a team sport that requires a variety of people with different skill sets. While most of your core team can be acquired/hired, having one or more co-founders can be very helpful, particularly in the early days of the company. It’s not uncommon to see a founding team made up of people with a mix of technical and business skills. In addition to bringing complementary skills and perspectives, co-founders can also make the journey more fun, engaging and less lonely. Given all the benefits, it seems like a no-brainer to have a co-founder assuming the founders have some form of an agreement establishing the “rules of engagement” between them.
This is done through a Founder’s Restricted Stock Purchase agreement, Operating agreement or IP Assignment agreement.
We oftentimes hear, “Why do need a formal agreement? We work really well together, we are totally aligned, we trust each other implicitly, etc. I am worried that this will create conflict and friction between us at this early stage of a startup.”
While all of that might be true, it further exemplifies why one should have founder’s agreements. Think about any team activity you have been a part of—whether in school, at work or in sports. How often have you asked yourself…
- What are everyone’s individual responsibilities?
- Why am I doing all the work here? He/she is in for a free ride and not doing their fair share.
- Is it time for me to leave now and do something different?
- Why are they getting involved in everything? This isn’t their role.
- Is my colleague that does more than expected planning on leaving?
- Do we really know what we’re getting into?
- What if this is different and harder than what we thought?
In the startup world, these issues are bound to surface, no matter how aligned the founding team is in the early days. And having a plan for them becomes even more important as the company raises capital from investors, hires a team, acquires customers and continues to scale. There will be differences of opinion on strategy, role and direction, and the answer can’t always be, “we will just resolve the issues through dialogue.”
The founder’s agreement provides the mechanism for founders to set the structure early on and the protocol to address ownership in case one of the founders leaves the company. Sometimes, it can also provide clarity to roles and responsibilities, though typically those issues are addressed through employment agreements and through the board of directors (once the company establishes a board).
Here are some key issues that should be addressed with a Founder’s agreement:
Established percentage of ownership
Typically, we see an equal split among founders, so if there are two founders, the ownership is split 50/50. If there are three founders, the ownership is split 1/3 each. While there is no right answer for how to split equity, be sure to consider factors like who is going to be working full time vs. part-time, who is working without salary, who needs a salary, what is the stage of the business when you brought on a co-founder, etc.
Vesting is a key mechanism to ensure that all the founders are motivated to work for the long-term future success of the company. We typically see 3–4 year vesting for founder stock. Your Founder’s agreement should also address what happens to unvested stock should a founder leave the company. While it is typical for unvested stock to go back to the company, you can include provisions to allow the company to buy back vested stock if the founders leave voluntarily.
Assignment of IP
It is typical for all founders to assign all intellectual property to the company. These concerns should also be addressed in your Intellectual Property Strategy.
In Case of a Liquidity
There are instances where the liquidity of the company’s assets makes the most financial sense. Your Founder’s agreement should clearly address the distribution of any returns and capital if this should happen.
how major decisions are made
No matter how solid the relationship may be between co-founders, there will be differences of opinion on strategy, role, or direction in various aspects of the business. And while the “we will just resolve the issues through dialogue” approach may be a diplomatic answer, it can quickly spiral into a breakdown in morale for your startup or even legal issues. Your operating contract should clearly outline the decision-making process within your company so there isn’t any conflict when major decisions have to be made.
While many of these issues might seem challenging to discuss, they help set the foundation for long-term success, make sure the founder’s incentives are aligned, and are best documented by working with an experienced startup attorney. As a prior founder of a venture capital-backed startup, I can speak from personal experience on how these issues, if not addressed early on, can create challenges in the future direction of the company.
If you are a founder of a tech startup and would like to discuss this topic, please reach out to me at [email protected]. We are also happy to connect you with experienced attorneys as you think about your Founder’s agreements.