What is a founders' agreement?
A Founders' agreement is an agreement that governs the relationship between the co-founders of a company, 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, which has led to a comparison with prenuptial agreements.
Why have a founders' agreement?
A founders' agreement is a baseline for how your co-founder relationships will work in the future. Having a founders' agreement in place can help:
clarify each founder's role in the business
provide 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
What are the common terms of a founders' agreement?
Roles and responsibilities
The agreement should clearly establish the roles and responsibilities of each founder. By way of example, thought should be given to which founder should take on 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 the company can deliver each day
Chief Financial Officer (CFO) - handles the money by creating budgets and financing strategies
A founders' agreement should determine the proportion of equity ownership of each of the co-founders (ie how much of the company each founder owns, typically in terms of company shares). This is usually determined by taking into account a number of factors such as the founders’:
existing intellectual property
Share ownership is also important because it ascertains the voting rights that each co-founder may exercise.
A vesting schedule regulates when each co-founder gets their shares. Having a vesting schedule (together with a grace period before any shares vest - this is known as a 'cliff') 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. This is usually 4 years. This means that if your co-founder takes 50% of the company's shares over 4 years and decides to leave after a year, they would be entitled to a quarter of their 50% (ie 12.5%). If they leave after 3 years, they would keep three quarters of their 50% (ie 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, adding a 'cliff' to your vesting schedule offers an incentive to co-founders without taking too much risk. For example, a one year cliff means that if a co-founder leaves during that 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.
How is a founders' agreement different from a shareholders' agreement?
The terms founders’ agreement and shareholders’ agreement are often used interchangeably. While a 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 that business between shareholders is conducted. As a result, a shareholders’ agreement is useful at the time of a company's incorporation while a founders’ agreement is advantageous before incorporation.
Essentially a founders’ agreement 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.
For more information on shareholders’ agreements, read Shareholders' agreements.