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Founders Agreement – How-To increase your start-up’s success rate

Your technology is No. 1; the breakthrough that the world is waiting for. You gathered a great founding team, exactly as required to attract those who can’t live with them/can’t live without them, Angels and VCs.

The Excel worked extra hours, the brainstorming was fabulous, and you have your executive summary all ready.

“One for all and all for one!” you guys declare to one another … and you truly mean it. “Let’s go conquer the world!”

Sorry to delay the party, but, well, wait just a minute …

Remember that strange lawyer? The one badgering you to clearly “translate” that exciting Three Musketeers saying into a boring legal Founders Agreement? The one expense you assumed you can spare? Big mistake!

A startups life is anything but stable. There will be highs, followed by sloppy lows, followed yet again by steep highs and so force. Each such turn shaking your startup, causing many unexpected things to happen, regarding the startup itself, but also regarding the founders’ personal life.

A Founders Agreement is somewhat like a Prenuptial Agreement. Who wants to deal with the implications of divorce, a minute before the wedding? Probably the one who understands that a minute before, when the couple is still in a honeymoon state of mind, is a much better time to resolve future conflicts, than at the time when all hell breaks loose.
In a startup’s life, this can happen much faster than expected and have lethal consequences, either for any of the founders (ask Reggie Brown from, or rather not from, Snapchat) or for your startup altogether (co-founders conflicts being one of the main reasons for startup’s failure.. and unfortunately most startups fail…)

Founders Agreements cover the separation issue as well, but include much more. They help provide the foundation for a successful business by outlining expectations, guiding decision-making, and reducing risk.

Every skyscraper needs stable foundation to help it survive through rough times and to support the additional floors as the skyscraper rises towards infinity … and so does your startup.

A to Z basics for to the right Founders Agreement

A proper Founders Agreement should address, at least, the following issues:

1) Founders’ Responsibilities

Not all founders can be CEOs. However, if all founders act as one (or there is no founder who is one), your startup is on direct road to failure.
A clear definition of the roles and responsibilities of each founder may materially reduce the risk for a major conflict between founders in the future and increase the startup’s success chances.

2) Decision Making

After you have your roles and responsibilities defined, you should also agree on the decision making mechanism.
For example:

  • Who will make the ultimate decisions?
  • What will you do in case of disagreements?
  • Which issues are regarded as “major” and thus require unanimous agreement of all founders or maybe just a special majority
  • How do you handle the sensitive issue of dismissing a founder from his employment with the startup?

Remember, any obstacle removed today, will allow your startup to take the right decisions in a timely manner in the future – the basis for any startup’s success.

3) Equity Ownership

Even if it’s not all about money, money is an important part of it; and nothing reflects the money potential like the allocation of the startup’s equity.

The initial equity allocation among the founders should reflect their relative contributions to the startup. One founder can provide more financing, another can assign vital IP to the startup, and a third can contribute his share by working around the clock.

One will resign after a year and another may stay with the startup all the way to NASDAQ. All of these and more have to be taken into account and properly weighed and balanced, so that each founder has the maximum incentive to provide the startup with what is required and expected from him.

4) Exit Strategy

Make sure that you agree on your startup’s vision and goals. Do you plan on making a quick hit-and-run by selling the startup to a “giant” as soon as practicable or do you plan to build a unicorn?

Even if eventually your initial goals are changed, the way you set them on day one will seriously impact how you setup and operate your startup – financial management, team building and much more.

5) Separation

Although, just like on your wedding night, you are certain that you and you co-founders will be there “till death do us part”, you are smart enough to know that this is not always the case.

Departure of a founder requires dealing with a variety of issues: from IP related issues, through equity holding and future decision making issues, to issues of non-compete and non- solicitation of employees, clients, and more.

The worse time to negotiate such issues is when a founder wishes (or is forced) to leave, which will probably be a shaky time for your startup and the relationship among the founders will not be at its prime. Good chance for such negotiations to lead to legal actions, causing material difficulties to your startup
The right time to negotiate these issues is, again, in the Founders Agreement, just before you start.

6) Ownership of Intellectual Property

As part of the Founders Agreement, each founder should clearly, irrevocably and explicitly assign to the startup all IP developed by him which is pertinent to the business of the startup, before incorporation of the startup.

This will be a basic demand of any investor, but can also prevent a situation where a founder is leaving and taking critical technology with him.

7) Dissolution

Who can decide to shut down the business? What happens in such case with the company’s assets (both IP and physical)? How will the assets, or the proceeds thereof, be distributed among the shareholders of the startup? …

These are only the very basic questions which should be sorted out when thinking about future.

One last thing – every Founders Agreement has to be tailor made, taking into the account the uniqueness of the business and the founders and their needs and desires. Signing a template that you downloaded from the web (even a damn good one) … will not get you across the street to the sunny side. Good luck, and enjoy the ride.

Adv. Michael (Misha) Gitterman is a partner at Eitan Mehulal Sadot Advocates & Patent Attorneys in the Corporate & Capital Markets Department.

 

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