One of the most useful tools for an early-stage startup is the founders agreement (or shareholders agreement). The founders agreement is not the agreement where the company issues stock to the founders; we call that a stock purchase agreement. Rather, it’s part roadmap and part accountability document.
Questions to Ask When Creating a Founders Agreement
Here are some of the key issues that founders should cover in a founders agreement:
How will founders split the equity?
The lazy approach is to divide up the equity equally among the founders, but that may not be fair based on what each founder is actually contributing in terms of money, time, expertise, etc. You can read more about this topic here.
What kind of vesting will apply to each founder’s stock?
The most common approach is “4-year vesting with a 1-year cliff”, which means that the stock vests over 4 years, with 25% vesting at the end of the first year, and the remainder vesting in equal monthly installments for 36 months. When this type of vesting is used, the stockholder owns his or her stock outright from Day 1, with voting and dividend rights, but the startup has the right to repurchase the unvested stock at the original cost if the stockholder leaves the company before the end of the vesting period. This protects the startup from having someone depart with a large chunk of unearned stock. Read more about vesting here.
What are the roles and responsibilities of the founders?
This is the accountability part of the founders agreement. What role will each founder take? Will each founder be working full-time? If a founder is working part-time, what will the minimum number of hours/week be, and will that founder be expected to go full-time at some point?
What money or other assets will each founder contribute?
If a founder has developed specific intellectual property, such as software or a patent, you can use the founders agreement to obligate that founder to contribute those assets to the company (but don’t forget to also document the actual transfer through an intellectual property assignment agreement). Similarly, if a founder is going to contribute a certain amount of cash, document that in the founders agreement.
How will founders be compensated?
It’s common for founders of early-stage startups to get no compensation other than their stock in the company, with the potential for its increase in value through their efforts. Indeed, founders should have enough in personal savings to live on for at least a year. Once the company has started generating revenue or has raised a significant round of financing, it’s reasonable for the founders to start taking a salary, but don’t expect it to be market-rate as if you were working for an established company.
How will important decisions be made?
Corporations have a very specific governance structure, unlike LLCs, but in the early years, it’s possible to introduce some flexibility on decision-making. If you want to specify that certain decisions require super-majority or unanimous approval, the founders agreement is a good vehicle for doing so. Otherwise, the default rule is that holders of a majority of outstanding stock decide matters put before the stockholders, a majority of the members of the board of directors decide board matters, and the CEO decides most lower-level day-to-day management decisions.
How do you remove a founder?
It’s quite common for there to be a falling out among founders, or for one founder to drastically reduce his or her contributions. So how do you remove that person? Typically this would be a decision for the board of directors, but in some cases, it might require a stockholder vote. Beyond just the process of removing someone, it’s useful to also spell out some criteria that would justify the removal of a founder.
What is the goal or vision of the business?
The founders agreement is also a good vehicle for defining what the goal and vision of the business will be. This can be the core of a set of principles and goals that will help the founders define and maintain company culture as the startup grows.
By taking the time to address these issues in a founders agreement, would-be founders can build a solid foundation for developing a strong and successful startup. As issues arise, startup founders can return to the founders agreement to determine whether everyone is living up to their responsibilities and whether the company is on track, consistent with the original vision. And often, the process of working out a founders agreement that addresses these topics will reveal whether all the founders are truly aligned and committed.