A guide to co-founders agreements

Start-ups are tough by their very nature.

There’s rarely enough money or time to go around and the future looks unknown.

You and your co-founders are living in each other’s pockets and away from partners, family and friends.

It’s no wonder that tempers can start to fray.

What’s more, as your business starts to grow, the working environment can change quite quickly.

One founder’s skills may become less important as the commercial landscape changes.

A founder’s working style or personality may have been essential to get the business going, but now be an obstruction to future progress.

It’s relatively common, in fact, for founders to leave the companies they started.

However, it’s something that’s rarely discussed.

Most seem to take the view that it’s something that won’t happen to them.

However, just as in business, risks are best managed if they’re understood and discussed about before they become a reality.

Use a co-founder’s agreement to protect your business from a relationship breakdown

A co-founders agreement has often been considered a form of ‘prenuptial agreement’ for startup businesses.

It governs the relationship between the co-founders of a potential company, (generally not yet formed), who have agreed to work together in order to develop a business concept and/or technology.

They play an important role before a company is incorporated.

It is an official contract signed between all the co-founders of the business.

Why have a co-founders agreement?

A co-founders agreement is a baseline for how your co-founder relationship will work in the future.

Having a co-founders agreement in place can help:

• Clarify each founder’s role in the business
• Provides a structure for resolving disputes among the founders
• Provide clarity if and when a founder wants to enter or exit the business
• Signal to investors that you have a serious business
• Clarify what happens if one of the founders becomes seriously ill or dies

What are the common terms of a co-founder’s agreement?

Roles and responsibilities

The co-founder’s agreement should clearly establish the roles and responsibilities of each founder.

By way of example, thought should be given to which founder should take the following roles:

• Chief Executive officer (CEO) – determines the company’s strategy, hires and builds the senior team and makes the final call on how company resources are used.
• Chief Operating Officer (COO) – handles the company’s operations and ensures that company deliver each day.
• Chief Financial officer (CFO) – handles the money by creating budgets and financing strategies.

Share ownership

A co-founder’s agreement should determine the proportion of equity ownership of each of the co-founders.

This is usually determined by talking into account a number of factors such as their monetary investment, experience, existing intellectual property and know-how.

Also, share ownership ascertains the voting rights that each co-founder may exercise.

Vesting schedule

A vesting schedule regulates when each co-founder gets their shares.

Having a vesting schedule (together with a grace period before any shares vest) means that instead of all the promised shares going to a founder immediately, they become fully entitled to them (or ‘vest’ in them) gradually over a period of time, usually 4 years.

This means that if you agree that your co-founder takes 50% of the company’s shares over 4 years and s/he decides to leave after a year, s/he would be entitled to a quarter of his/her 50% (i.e. 12.5%).

If s/he leaves after 3 years, s/he would keep three quarters of his/her 50% (i.e. 37.5%).

Having a vesting schedule is beneficial, as it incentivises founders to stay in the business longer; the longer they stay, the more of the company they own.

Further, having a grace period to your vesting schedule offers an incentive to co-founders without taking too much risk; for example, a one-year grace period means that if a co-founder leaves during the year (or does not deliver), they leave without any equity in the company.

Vesting schedules are also advantageous if the company seeks to raise a round of financing.

Investors are often deterred by non-contributing investors who hold equity, so it is worth setting out what founders are entitled to and when they’re entitled to it from the very outset.

Confidentiality

The agreement should also have a provision which prohibits explicitly any founder from soliciting any business information or sensitive information of any client or employee in case s/he leaves.

Such a clause will protect the business from any founder who leaves the business duplicating the business idea directly.

How is a co-founder’s agreement different from a shareholders agreement?

We are often asked this question.

The truth is that the terms of a co-founder’s agreement and shareholders agreement are often used interchangeably.

While a co-founders agreement looks to establish the basics, such as the roles and responsibilities of the founding team, equity ownership and vesting, a shareholders agreement regulates the way the business between the shareholders is conducted and therefore, is useful at the time of a company’s incorporation.

A co-founders agreement therefore is simply a form of shareholders agreement suitable at the early stages of the business and will typically be replaced by a more complicated shareholders agreement once the business takes on more shareholders.

You can find our co-founders agreement template here