Founders Agreement

What is a Founders Agreement?

A Founders Agreement is a legal contract between the founders of a startup or company that outlines the terms and conditions of their relationship. It covers key aspects of the company’s operations, equity distribution, roles and responsibilities, intellectual property (IP) ownership, decision-making processes, and the handling of disputes. This agreement is designed to establish clear expectations and protect the interests of all parties involved in the early stages of the business.

Why is a Founders Agreement important?

A Founders Agreement is crucial because it:

• Clarifies ownership and equity distribution among founders.
• Defines roles and responsibilities, helping prevent conflicts and misunderstandings.
• Protects intellectual property and ensures proper ownership.
• Sets expectations for decision-making and management.
• Establishes a framework for dispute resolution and exits, ensuring smooth business operations.
• Helps in raising funds by making the business structure clear to investors.

What should be included in a Founders Agreement?

A comprehensive Founders Agreement generally includes the following components:

• Equity and Ownership: Clear definition of the equity distribution among the founders and any vesting schedule (i.e., how and when the founders earn their ownership stake).
• Roles and Responsibilities: The roles and duties of each founder, including their involvement in day-to-day operations and long-term goals.
• Decision-Making and Voting Rights: How key decisions will be made and voting rights among the founders, especially for major business decisions.
• Intellectual Property (IP) Rights: Clarification of who owns the company’s IP (patents, trademarks, software, etc.) and how it will be handled if a founder leaves the company.
• Vesting Schedule: Defines the vesting of equity over a period of time to ensure founders remain committed to the company.
• Exit and Buyout Clauses: Conditions under which a founder can exit the company, or be bought out, including the valuation process.
• Confidentiality and Non-Compete Clauses: Agreements to protect confidential information and prevent founders from starting a competing business during or after their association with the company.
• Dispute Resolution: The method for resolving disputes, including whether arbitration, mediation, or court proceedings will be used.
• Death or Disability of a Founder: Procedures to follow if a founder becomes incapacitated or passes away.

Why is equity distribution important in a Founders Agreement?

Equity distribution is crucial because it defines the ownership structure and helps align the interests of all the founders. It reflects the value each founder brings to the table, whether in terms of money, time, skills, or intellectual contributions. The Founders Agreement should clearly specify:

• How equity is divided among the founders.
• Vesting schedules to ensure that founders earn their equity over time.
• Ownership percentages and how they can change in the future, especially if additional capital is raised.

What is a Vesting Schedule, and why is it important?

A vesting schedule outlines when founders earn their equity over a period of time, typically over a 3 to 4-year period with a one-year cliff. This means: Founders earn equity gradually, ensuring that they stay committed to the company. If a founder leaves before the vesting period is complete, they forfeit the unvested portion of their equity. A vesting schedule ensures that founders remain motivated and that the business is not left with founders who are no longer actively involved.

What happens if a founder leaves the company?

The Founders Agreement should include provisions for what happens if a founder leaves the company. These provisions typically address:

• Voluntary departure: A founder who decides to leave may be required to sell their equity back to the company or remaining founders, often at a predefined valuation or at fair market value.
• Involuntary departure: If a founder is removed from the company or cannot continue due to illness, the agreement will outline the conditions under which the remaining founders can buy back their equity.
• Exit strategy and buyout terms: The agreement should define how the exit process works and what the buyout terms will be.

Can a Founders Agreement be amended or updated?

Yes, a Founders Agreement can be amended or updated as needed. However, any changes to the agreement should be made in writing and require the consent of all parties involved. It’s important to revisit the agreement periodically to ensure it reflects the evolving nature of the business and the contributions of each founder.

What is the difference between a Founders Agreement and a Shareholders Agreement?

A Founders Agreement is typically signed by the co-founders of a startup and focuses on their roles, responsibilities, and equity arrangements in the early stages of the business. It is specifically tailored to the relationship among the co-founders and addresses key issues like IP, decision-making, and vesting. A Shareholders Agreement, on the other hand, is a broader document that governs the relationship between all shareholders in the company, including investors. It typically deals with the rights of shareholders, transfer of shares, and governance issues. The Shareholders Agreement is relevant once the company has raised capital from investors and has a larger group of shareholders.

Can a Founder’s Agreement include clauses for Non-Compete and Confidentiality?

Yes, a Founders Agreement can include Non-Compete and Confidentiality clauses:

• Non-Compete Clause: Prevents a founder from starting or joining a competing business during or after their involvement with the company. This is important for protecting the company's market position.
• Confidentiality Clause: Ensures that all founders keep proprietary business information confidential, even after they leave the company. It covers trade secrets, customer lists, and other sensitive information.

How does a Founders Agreement protect the intellectual property (IP) of a company?

A Founders Agreement ensures that any intellectual property (IP) created by the founders during the course of their work for the company is owned by the company, not the individual founders. This is typically achieved through:

• Assignment of IP: The agreement should specify that any IP created by a founder, whether before or during their tenure, is automatically assigned to the company.
• Ownership of IP after departure: If a founder leaves, the agreement should ensure that any IP they developed remains with the company.

Should an NDA (Non-Disclosure Agreement) be part of the Founders Agreement?

Yes, an NDA can be included in the Founders Agreement to ensure that all founders agree to keep sensitive business information confidential. This is important when dealing with trade secrets, business strategies, or proprietary technology. The NDA ensures that founders are legally bound to not disclose such information to third parties during or after their association with the company.

How does a Founders Agreement address dispute resolution?

The Founders Agreement typically includes a dispute resolution clause that outlines how disputes among the founders will be resolved. Common methods of dispute resolution include:

• Mediation: A neutral third party facilitates a discussion to help the founders reach a mutually agreeable solution.
• Arbitration: A neutral arbitrator makes a final, binding decision.
• Court Litigation: If other methods fail, the founders can resolve their disputes in court, though this is often seen as a last resort.

Can the Founders Agreement be enforceable in India?

Yes, a Founders Agreement is legally enforceable in India under the Indian Contract Act, 1872, provided the agreement is entered into voluntarily, with the consent of all parties, and contains valid consideration (i.e., something of value). It is advisable to get the agreement notarized and, if necessary, registered to ensure its legal validity.

How can a Founders Agreement help in raising capital?

Investors want to ensure that a startup has a clear structure and defined roles before they invest. A well-drafted Founders Agreement demonstrates that the founders are aligned, reducing the risk for investors. It can also provide clarity on:

• The equity distribution and how it may change.
• Vesting schedules to ensure that the founders stay committed.
• The process for decision-making and conflict resolution. By providing a clear, organized structure, the Founders Agreement can help in securing funding from investors.

Is a Founders Agreement legally required in India?

While a Founders Agreement is not a legal requirement in India, it is highly recommended, especially for startups that plan to scale, raise capital, or establish formal relationships with partners. Having a Founders Agreement in place helps clarify expectations, reduce misunderstandings, and protect the interests of all parties involved.