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Founer or Co-Founder Agreement
At the early stage of a starup when co-founders come together for a starup and they start building a company, that stage is curcial to enter into an agreement that governs the professional relationship between the founders and also pens down mutual understanding for future business plans. Co-Founder's agreement reduces chances of any disputes amongst the partners in the future.
Contents of a Founder’s Agreement
The Founder’s Agreement contains the following:
- Definition of business
- Structure of the business to be adopted in the future
- Ownership of Intellectual Property Rights (such as copyright, patent, trade mark, etc.)
- Ownership stake of parties in the business
- Roles & responsibilities of parties
- Decision making & voting mechanism
- Performance criterion & firing of parties
- Exit rights of parties
- Dispute resolution mechanism
Laws governing the Founder’s Agreement in India
The different laws which govern various aspects of Founder’s Agreement in India are as follows:
- The Indian Contract Act, 1872
- Arbitration and Conciliation Act, 1996
- The Foreign Exchange Management Act, 1999
- Companies Act, 2013
- Indian Partnership Act, 1932
- Limited Liability Partnership Act, 2008
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Frequently Asked Question
What is the importance of entering into such an Agreement?
● Provides clarity on business
One of the most important aspects that a Co-founder’s Agreement covers, is naming and defining the business in terms of what product would to be built, and/or what services would be offered. The clarity on this aspect avoids conflicts in the future amongst the founders. Also, it is only when after you would define the business that it would make sense to add a non-compete clause, that would prevent the founders to leave the business and build a competing business.
● Intellectual Property Rights (“IPRs”)
There are a lot of IPRs that are created while the founders are working towards their business goals, such as codes, softwares, brand name, logo, financial plans, marketing plans, process, etc. These could be a matter of copyright, trademark, patent, know-how, etc. And these ideally become the property of the founder who creates them. Therefore, it becomes very pertinent to transfer these IPRs in favor of the business, as these are created along the way by the founders while working for the business.
The most important aspect of a business is the percentage of the ownership stake that each founder or co-founder will receive after the business adopts a more formal structure (in the shape of Partnership firm, or LLP or Company). This is by far the most important clause and needs much deliberation upon as majority of the disputes amongst the founders in the future, relates to this.
● Share Vesting
If you offer the shares to the founders right upfront after incorporation of the company, they might leave the company by selling their stake and not stick and work for the company. This could be disastrous for the company’s interests. Therefore, you can opt for share vesting, in which case the shares will be granted to the founder, but these shares would vest in the founders after a particular time period. This demotivates the founders from leaving the company, because if they leave early they will get either nothing or very little percentage of the shares granted to them.
Do you want to put lock-in on the founder or co-founder’s shares? Lock-in simply means that they won’t be able to sell or transfer their shares to anyone during a specified lock-in period of say 1 year, or 2.
● Roles and responsibilities of founders
The role and the responsibilities of each of the founders and co-founders need to be agreed upon amongst them and laid down in the Co-founder’s Agreement.
Even though, in the beginning of the start-up journey everyone will be working on almost everything, yet you need to specify this for the sake for efficiency and clarity. It is much better once everyone is clear on their exact role in the business and for what they are responsible. It improves ethics, and provides efficiency and clarity.
● Decision making process
There are a lot of decisions that are required to be made in a business, from product launch to marketing, there could be plenty of decisions that are required to be made. The more the number of founders/co-founders, the more chances are there of deadlocks in the decision making.
How would these deadlocks be resolved? It is important to deliberate upon a pre-hand solution, so that deadlocks can be resolved in a timely manner before they affect the business.
● Performance benchmark and firing
Imagine a situation, where one of the founders has lost interest in the business and starts delivering poor performance in the business, or takes up an alternate employment and is unable to give time to the business? Would it not be better, if you provide for performance benchmarks in the agreement, and fire the founders from the business if they fail to meet such benchmarks? You can provide for such arrangement in the Co-Founder’s Agreement.
● Dispute Resolution
Most of the times, you are starting a new business, either with your friends, family or the people with whom you have close relations with (such as long-term professional colleagues) and in the beginning, everything seems to be going sweetly between them. This is the reason why they ignore to provide for any dispute resolution mechanism. However, as can be witnessed from a plethora of such-like start-ups, disputes are bound to arise. And it only makes sense that you provide for a mechanism to resolve it, one that saves time, cost and reputation, i.e. Arbitration.
A non-compete prevents the founders from starting a competing business for a few years after he/she quits the start-up.
A non-solicit clause prevents such leaving founder/co-founder from soliciting away the clients, employees or the suppliers, when they themselves are leaving the start-up.
● Non-Disclosure Agreement
There is a lot of important and sensitive information in any business, such as business idea or plan. If such information is leaked out and reaches a competitor’s ear, it can cause potential loss to your business. This is why you enter into an NDA, not only with the founders/co-founders, but also with your employees, since they will also have an access to a lot of pertinent information.
Non-disclosure Agreement (NDA) is an agreement that protects such information and prevents the founders/co-founders or employees from leaking out such information to anyone.
● Exit Rights
Even though these are the rights that you usually provide for in the Shareholders Agreement (SHA), however nothing stops you from agreeing to these rights in advance amongst your founders/co-founders.
When is the right time to enter into a Founder's Agreement?
The most appropriate time to enter into a Founder’s Agreement is when you along with your co-founders decide to start working upon a business plan.
Is the Founder’s Agreement required to be notarized?
Yes, the Founder's Agreement has to be executed on non-judicial stamp paper for respective value and get notarized from the notary person, in order to make the agreement a legally enforceable one.
How do I decide the equity/percentage split between myself and the co-founders?
The most important aspect of a business is the percentage of the ownership stake that each founder or co-founder will receive after the business adopts a more formal structure (in the shape of a Partnership firm, or LLP or Company). This is by far the most important clause and needs much deliberation upon as the majority of the disputes amongst the founders in the future, relates to this.
There are a number of mechanisms in which the stake could be divided amongst the members. These can broadly be divided into three categories.
a)Equal division: If the founders decided that there is an equal contribution by them towards the business, they can simply go for an equal stake.
b)Division on the basis of efforts: Often, not all the founders or co-founders are contributing equal efforts towards the business. Maybe, one or only a few of them are engaged in the core tasks, and others are working on non-core tasks. Therefore, there could be division on the basis of efforts.
c)Division on the basis of capital contribution: There can also be a division on the basis of the amount of capital (i.e. cash or cash-equivalent) contributed by the parties.
d)Mix of above factors: Alternatively, there can be division of stake on the basis of the amount of efforts contributed as well as on the basis of the amount of capital contributed by each party.
There are many different online toots that you can use to calculate the equity stake to be divided amongst the founders, that take into consideration a lot of factors, including the ones we discussed above. A couple of such websites are foundrs.com and seedcamp.com (and there are many others).
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