What is a Founders’ Agreement?

Starting a business with partners is exciting, but the honeymoon period often doesn’t last. Founders who once shared big dreams may soon find themselves in disputes over responsibilities, effort, and ownership.

In this article, we’ll break down why founder’s agreements are essential, the key areas they cover, and practical steps for creating one that protects your startup’s future.

What is a Founders Agreement, and Why is it Crucial?

A founders agreement is a legal document that establishes the roles, responsibilities, and rights of each founder in a startup. Think of it as a prenuptial agreement for business partners—it outlines how decisions are made, who owns what, and what happens if someone wants to leave the company or if the company dissolves.

Unlike a shareholders agreement, which is typically formalized after a company has stabilized its business direction, a founders agreement is an essential early-stage document that addresses the fluid nature of startups. It’s especially valuable in ensuring that everyone is on the same page as the business goes through early pivots and changes.

1. Founders Agreement vs. Shareholders Agreement: Timing Matters

For startups, entering a founder’s agreement before a shareholder’s agreement can be beneficial. Here’s why:

• Founders Agreement First: A founders agreement is designed for the initial, uncertain stages of a startup. In these early days, roles and responsibilities are still evolving as the business idea develops.
• Shareholders Agreement Later: A shareholders agreement assumes fixed roles and a stable business direction. This level of formalization is best suited once the startup has finalized its Minimum Viable Product (MVP) and has a clearer path forward.

“When you’re a startup testing a new idea, you’ll likely pivot several times before setting your final direction. We think it makes sense to nail down your shareholders agreement once your MVP is set.”

2. Defining Key Performance Indicators (KPIs): Balancing Contributions

One common issue in startups is that not all founders contribute equally, which can lead to friction. A founder’s agreement can prevent resentment by defining clear Key Performance Indicators (KPIs) for each founder.

• Setting Expectations: Outline specific responsibilities and expected contributions for each founder. For instance, how many hours per week each founder will dedicate, specific milestones, or deliverables they must meet.
• Consequences for Non-Performance: Include clauses that address what happens if a founder doesn’t meet the agreed standards. This might mean changing their role, reducing their ownership stake, or even replacing them.

“We can avoid this disgruntled feeling by setting out clear KPIs from the start… so it becomes clear when someone doesn’t perform to standard, and the consequences should be spelt out too.”

3. Ownership and Intellectual Property (IP) Protection: Securing Collective Rights

One of the biggest risks in partnerships is the potential for disputes over ownership. A founders agreement can help clarify who owns what and how ownership can evolve.

• Collective Ownership: Establish that all work done by the founders belongs collectively to the company. This includes intellectual property such as ideas, inventions, or designs created for the business.
• IP Clauses and Restrictions: Include a clause that protects the company’s intellectual property by restricting founders from using company assets or information for personal gain.
• Evolving Ownership Percentages: Detail how ownership may change if certain expectations aren’t met. For instance, a founder who doesn’t meet KPIs may see their ownership percentage adjusted.

“Make it clear from the start whatever is created is owned collectively… and how these percentages could evolve over time if expectations are not met.”

4. Planning for the Future: Setting Terms for Different Scenarios

Every business journey has its highs and lows, and a well-crafted founders agreement prepares for both. Your founder’s agreement should outline potential outcomes for various scenarios and what they mean for each founder.

• Positive Outcomes: Define what happens if the startup succeeds, such as incorporating the company or bringing in venture capital funding.
• Negative Outcomes: Plan for potential disputes or business dissolution. A founder agreement can act as a “prenup” that sets out the asset distribution and ensures a fair division of ownership if the partnership dissolves.

“If things turn into a nasty divorce, see this document as a prenuptial agreement that sets out the asset distribution and who gets custody over the company.”

Conclusion: Building a Strong Foundation for Long-Term Success

A founders agreement is more than just a legal formality—it’s a tool that helps set your business up for success by creating a clear, fair framework for the roles, responsibilities, and ownership among founders.

By addressing potential issues early on, you can avoid costly disputes and ensure that all founders remain aligned with the startup’s mission and vision. If you’re starting a business, don’t wait for conflicts to arise—put a founder agreement in place and build a strong foundation for your startup’s future.