The 3 Essential Things Needed in a Founders' Agreement
Q: How do you suggest structuring a founders' agreement?
-- Shine Reuben
A: When getting a new enterprise off the ground, there is nothing more important than having a clear agreement amongst the founders around a handful of key issues that are critical to your ability to safeguard the future viability of your new enterprise and to raise venture money. These key issues cover three really important areas: the roles and responsibilities of the founding team, equity ownership and vesting and IP ownership.
Confused? Here is a more detailed breakdown.
1. Roles and responsibilities. You are going to want to make sure you have a clear understanding around roles and responsibilities up front. Yes, it is critical that a co-founding team collaborate and to create an open and shared culture amongst themselves but that shouldn’t necessarily mean everyone is in charge of everything. I have seen too many startups make the mistake of thinking that every decision has to be made collectively and every founder has control over every decision. That will inevitably create confusion and frustration.
I’m not saying you shouldn’t create an environment in which major decisions are discussed and driven be a consensus. What I’m saying that you should strive to establish some clear lines of primary responsibility and enable a functional management system that enables each of the co-founders to have clear responsibilities and reporting obligations. Doing so will go a long way in helping you minimize growing pains. Remember, not every co-founder should be a co-CEO.
2. Equity ownership and vesting. You’ll need to allocate the ownership of your new enterprise amongst the founding team. While this is a subjective matter and can sometimes be very delicate, it is imperative that you nail down how you will split up the equity between the founding team upfront to make sure there are no misunderstandings or hurt feelings once things get off the ground.
Remember that you typically will have 90 percent to play with, as you most likely want to set aside at least a 10 percent option pool for future rank and file hires. Also remember there is no rule that says all of the co-founders will have equal ownership of the new enterprise -- and that’s where it gets a little tough. You may have to tell your co-founders they are not your co-equal. But it’s always better to have that conversation on day one and not to move forward with a new enterprise and then get stuck on who owns what.
Also, to stay on the theme of planning ahead, you need to implement market vesting terms for all of the founders’ equity (in case there is a split). What that means is that each of the founders must earn their equity by contributing to building value in the enterprise. The most common vesting terms are those that occur monthly or quarterly over three or four years. You do have some room to play with the parameters of the founders’ vesting schedule, including the amounts that are fully vested up front but you should stay within market parameters.
Remember that you’re not doing this just because investors expect it. You are doing it because you will create very significant enterprise risk if one of the members of the founding team picks up and leaves for the beach and you are forced to use dilutive equity to bring on replacement talent, not to mention you don’t want to create any incentives for a free ride. So, be smart. Get the equity ownership conversation nailed early and implement appropriate vesting terms up front.
3. IP assignment. When you and your co-founders begin to iterate on an idea and develop a business plan or begin to build a product or a platform, you are creating intellectual property (IP). IP comes in many forms but make sure that whatever IP is being developed for your new enterprise belongs to the entity and not the individuals behind the development of the IP. This concept extends to not only your co-founders but all of your employees, consultants and contractors.
Unfortunately, I have seen too many founders work, iterate and develop an idea or a technology but separate before the IP that has been developed has been assigned from them into the entity, meaning your new enterprise may not have rights to various things that it will need to evolve its business or otherwise raise capital.
Getting IP assigned into the entity is simple and there are many forms available online that get this basic assignment accomplished. Do it on day one and don’t wait too long.
Unfortunately, co-founding a business isn’t too dissimilar from marriage. You can start with all the right intentions and never imagine separating. But it does happen. Plan ahead. Otherwise, you will jeopardize the viability of your new enterprise.
Bo Yaghmaie is the head of Cooley LLP’s Business and Technology practice in New York and an active participant in the New York startup and venture capital ecosystem. He teaches at Cornell University Law School, serves as a Tech Stars mentor and regularly counsels leading venture-capital firms and a broad range of venture-backed companies from inception through transformative transactions such as financings, mergers, acquisitions and IPOs.