Key Terms to Include in a Founders’ Agreement
As a company scales, one of the most important things co-founders can do is formalize their relationship. Yet Forbes lists the absence of a founders’ agreement among the top 10 legal mistakes made by startups. And poorly-constructed agreements lead to founder conflict which, according to Y-Combinator co-founder Paul Graham, is one of the most fatal mistakes that kill startups. Where do most agreements go wrong? What key terms should your founders’ agreement (FA) include?
4 Key Areas of a Founders’ Agreement
Roles & Responsibilities
Define who does what and titles.
Rights & Rewards
Describe decision-making rights and rewards, such as who sits on the board.
List assets such as IP, network, capital, and time each co-founder invests
Stipulate provisions such as vesting.
Common Mistakes in Founders’ Agreements
- Failing to divide duties according to each founders’ skill.
- Lacking consistent decision-making thresholds.
- Requiring unanimous consent on all decisions and neglecting to articulate deadlock provisions.
- Assuming that implicit understandings exist.
We talked to a range of leading entrepreneurs about their personal experience with founders’ agreements. Some successfully operated without formal, written founders’ agreements. Others eagerly established formal agreements at the outset that ended disastrously while others carefully crafted agreements over time that have helped keep their company on course. We can’t give you a precise rule for creating a founders’ agreement and some co-founder conflict is inevitable. But we can provide a framework that will help you avoid common mistakes and equip you to handle conflict.
Roles & Responsibilities
When co-founders possess distinct individual skills, roles can fall into place organically and you may be tempted to forgo writing a founders’ agreement. For instance, when three co-founders launched BlackBuck in 2015, they divided roles according to skillset. Each agreed to accept a functional lead that aligned with their skills: fundraising, operations, and sales. But many co-founders have a significant overlap in skills and expectations. Addressing key terms—roles and responsibilities—in your founders’ agreement becomes critical.
Defining Who Does What
BlackBuck’s co-founders decided not to write a formal agreement at the outset. However, they took the time to clearly establish expectations about responsibilities and role divisions. Alignment on those decisions enabled their startup to scale exponentially. Between July and December 2015, they expanded from three locations with three clients to 54 cities with 50 clients and the team grew from 35 employees to 250. In less than two years, they developed a technological platform and built a network that completely revolutionized India’s trucking industry. By the end of 2018, BlackBuck grew to over 2,000 locations, serving 10,000+ clients.
The decision to forgo a written founders’ agreement worked for BlackBuck because they shared complementary expectations and verbalized their agreement about roles and responsibilities.
BlackBuck’s founders also unanimously agreed upon titles and who would serve as CEO. That scenario is relatively rare. Often, when two or more co-founders exist, each expects to become CEO. Planning to discuss your expectations for titles and general responsibilities with your co-founder early can mitigate future conflict.
Inevitably, during early stages—when uncertainty abounds—and scaling—where needs change rapidly—titles and roles may shift. You can stipulate that roles will be reevaluated periodically, such as every six months, and, if necessary, redefine titles and roles to reflect changing needs.
Delineating titles and roles shouldn’t limit a co-founder’s role. Instead, it helps provide structure by distributing responsibilities.
Questions to Consider about Roles & Responsibilities
- What are the titles of each founder?
- Do you have clearly defined responsibilities for each role?
- Have you created limits for roles?
- How will you allow for change as founders’ roles change over time?
Rights & Rewards
Founders’ rights tend to change once investors get involved, so clear delineation at the outset can help to avoid future conflict and create a culture of openness.
This section of your founders’ agreement covers two primary areas. First, it defines who holds final authority within different aspects of the business. Second, it stipulates what circumstances matter.
Most founders make decisions based on their experience, roles, and expectations. Sometimes, perspectives don’t align. Lacking a decision-making path can lead to conflict. For example, a technical co-founder might set a one-year goal for developing a product, while a business-oriented co-founder might want to guarantee investors that the product will be ready in 6 months. Who has the right to override which decision, given that decisions affect the same pool of resources?
Some critical decisions—like key hires, equity grants, removal of a founder, long term commitments, and raising new equity—require the Board’s approval. Typically, they also need consensus from all founders. What happens if you disagree? Your founders’ agreement should address you you will resolve disagreements and deadlock.
Even if you plan to promote a collaborative culture, not all decisions should be made collectively. Your founders’ agreement should stipulate who has the right to make any given decision. It should propose a course of action if partners disagree.
How much compensation should each co-founder receive? Most founders ask themselves, “what percentage of ownership will I get in return for what I am putting into this venture?” Wasserman discovered that 73% of founding teams split equity within a month of founding. But when crafting a founders’ agreement, equity is the last item that you should discuss.
Most founders opt to divide equity equally or calculate a percentage of equity split based on the contributions each co-founder makes. Many approaches and methods for calculating equity exist. But calculating percentages is highly subjective. Calculations are often based on the founders’ past contributions—which many overvalue—and expected future contributions—which are impossible to accurately predict.
While your FA can cover the allocation of equity, you also have the option of making the equity split a separate legally binding document. Read more about deciding how to allocate equity in How To Think About Equity Splits. When discussing equity and decision rights, resist the common temptation to conflate the two.
Many founders make the mistake of creating a 1:1 correlation between equity with decision rights. But this often leads to future conflict.
For instance, a technical co-founder who contributed the founding idea and IP may have a higher equity stake with lower decision rights. The percentage of equity ownership and decision rights do not have to match. Consider structuring your FA to address equity and decision-making separately.
At the start of a company, all founders have representation on the board. Typically, following the seed round, founders can specify who will represent the company on the board, and stipulate observer rights for other founders. An observer can attend Board meetings and participate in Board discussions but does not have the ability to vote on issues. Establishing observer rights minimizes the risk of co-founders feeling excluded.
Questions to Consider about Rights & Rewards
- Who will decide what?
- What is the time limit for decision making?
- How will you handle deadlock?
- By what method will you reach consensus when making important decisions?
- Which decisions can be made by a single person, and which need consensus by both/ all founders?
- Did you separate equity from decision rights?
- Who will represent the company on the Board?
- Will founders who don’t have Board representation receive observer rights?
- How will you allocate equity?
Time & Interest
It is important to take into account whether each founder will work full-time or not. For instance, at an early stage company, one co-founder may work full-time, while the other works half-time on the venture while continuing to work half-time elsewhere. Retaining a role in another company minimizes the risk for that co-founder. Similarly, since many founders want to have the ability to take advantage of opportunities—as investors, consultants, etc.—outside of the startup, you also need to agree on basic time issues. How many hours constitute full-time? If one person follows a 50-hour work while the other consistently works 80 hours per week, resentments will begin to form.
Intellectual Property (IP)
When you and your co-founders iterate on an idea and develop a business plan or begin to build a product or a platform, you are creating intellectual property (IP).
Securing IP is a good business practice and prevents a technical co-founder from walking away with a crucial patent if he or she leaves the company. Equally important, it can protect you. If you own the IP for an algorithm and allocate it to the company, it’s no longer yours. If the company fails, you have lost any rights over the IP you created.
Your founders’ agreement can introduce appropriate IP assignment provisions. Incidentally, your startup should secure IP rights not only from your co-founders but from your employees, consultants, and contractors.
IP comes in many forms. Your FA should stipulate that whatever IP is produced for your startup belongs to the company, not to the individuals who developed it.
Some founders have a strong network they are willing to share that would increase the chances of a company succeeding. Others feel reluctant to share their network initially, while they’re unsure of the future success of the company. For instance, when launching Endeavor, a nonprofit that promotes the power of entrepreneurship, co-founders decided to split equity equally. However, when the company developed in a way that differed from the original vision, the co-founder who disagreed with the venture’s new direction, refused to share his network. Without a provision about founders’ networks in an FA, a founder can continue to retain original equity in such a case.
Capital & Confidentiality
Your founders’ agreement should list if either founder contributed personal funds to the venture and describe the terms for capital usage. To demonstrate commitment and protect valuable business information, your FA should also include a standard confidentiality clause.
Questions to Consider about Commitments
- How much time will each founder commit to the startup and for what duration?
- Did you specify the number of hours that you consider full-time?
- What is each founders’ obligation to the company, in light of future external opportunities that could conflict with current roles and expectations?
- Did you include an IP provision?
- What is each founder’s financial obligation to the company?
- Did you record any capital contributions by a founder, and terms of usage?
- Will founders share networks and connections?
Even with a thoughtfully crafted founders’ agreement, unpredictable issues will arise. Your FA can provide provisions that help establish a process for dealing with unexpected scenarios, such as if a partner leaves. Founders often don’t feel the need for contingency provisions, but at a minimum, including a vesting period for all co-founders can protect your startup and your relationship.
Instead of receiving equity rights instantaneously, vesting defines the criteria co-founders must meet to earn their equity. Commonly, vesting stipulates that founders must either work for a set period of time or meet certain milestones before their equity becomes available. Vesting provisions help ensure that co-founders will remain actively involved in and committed to the startup. The most common time-based vesting term occurs quarterly over four years, with a one year cliff. That means that the vesting schedule will not be enforced for the first year. Most founders opt to include a time-based vesting schedule in their FAs, despite the fact that time-based vesting only measures the quantity of time, not the quality of work.
Questions to consider about contingencies
- Did you include time-based or milestone-based vesting terms?
- What happens if a founder leaves or is asked to leave?
- If a founder leaves do other founders have the right to buy unvested shares or do these go back to the common pool?
- What happens if a founder wants to sell part of his or her shares?
- How will you handle the acquisition or sale of the company?
- Will you create an option pool to attract new hires or give additional grants to the existing team? If so, how much of the equity will you reserve for that?
A founders’ agreement serves several important functions. On the most basic level, it establishes the roles, responsibilities, and rights of founders. It gives co-founders the opportunity to negotiate a shared vision. Perhaps most importantly, it provides a way to resolve future contentious issues. Many helpful online resources exist to help you get started on drafting a founders’ agreement with standard terms and provisions. But don’t rush the process. Plan to have ongoing conversations and document your expectations in writing, especially if areas exist where you and your co-founder disagree.
Checklist for Founders’ Agreements
Questions about Roles & Responsibilities
What are the titles of each founder?
Do you have clearly defined responsibilities for each role?
Have you created limits for roles?
How will you allow for change as founders’ roles change over time?
Questions about Rights & Rewards
Who will decide what?
What is the time limit for decision making?
How will you handle deadlock?
By what method will you reach consensus when making important decisions?
Which decisions can be made by a single person, and which need consensus by both/ all founders?
Did you separate equity from decision rights?
Who will represent the company on the Board?
Will founders who don’t have Board representation receive observer rights?
How will you allocate equity?
Questions about Contingencies
Did you include time-based or milestone-based vesting terms?
What happens if a founder leaves or is asked to leave?
If a founder leaves, do other founders have the right to buy unvested shares or do these go back to the common pool?
What happens if a founder wants to sell part of his or her shares?
How will you handle the acquisition or sale of the company?
Will you create an option pool to attract new hires or give additional grants to the existing team? If so, how much of the equity will you reserve for that?
Questions about Commitments
How much time will each founder commit to the startup and for what duration? Did you specify the number of hours that comprise a full-time?
What is each founders’ obligation to the company, in light of future external opportunities that could conflict with current roles and expectations?
Did you include an IP provision?
What is each founder’s financial obligation to the company?
Did you record any capital contributions by a founder, and terms of usage?
Will founders share networks and connections?
Templates & Tools
- Harvard Business School’s Founders’ Agreement Template can be downloaded and customized.
- FAST Agreement (Founder/Advisor Standard Template) by Founder Institute provides a downloadable template that contains basic terms commonly found in FA.
- Startupcommons offers an online template that can be downloaded and customized.
- “Founders’ Agreement Overview,” by the University of Pennsylvania provides a checklist of basic questions that co-founders should discuss.
- “The 3 Essential Things Needed in a Founders’ Agreement” by Bo Yaghmaie, Head of New York Business & Finance Group, Cooley LLP, explores 3 core issues that a founders’ agreement should cover: roles and responsibilities, equity, and IP ownership.
- In “How To Create the Perfect Co-Founder Agreement With Your Business Partner,” the Founder Institute outlines topics that co-founders should address before launching a venture.
- “How To Draft An Iron-Clad Founders’ Agreement” by Jiah Kim provides founders’ agreement ideas that will help your startup grow, and avoid common founder-related issues.