A Founders Agreement in the Hand is Better than a Lawsuit in the Bush

Founders may operate on a handshake and the best of intentions but a lot can go wrong between the visionary process and when a business is actually launched. The press coverage on trending startups makes it sound as if success happens overnight but, in most cases, you will struggle for a long time before your business (or partnership) will either thrive or fold so it is important to minimize risks upfront by setting up your partnership relationships for long term success.

While it may be uncomfortable for founders of a new business to talk about issues such as compensation, day-to-day responsibilities, management roles or what happens if one partner wants out, this is one area of responsibility you don’t want to procrastinate. A friendly relationship can quickly sour when the business booms or busts – partners either get greedy or they point fingers at the other when the business doesn’t do as well as planned. For this reason, many attorneys refer to founders agreements as pre-nups for startups though, if that were the case, I would refer you to a good divorce lawyer….

The reality is that a founders agreement is simply written proof of all the things you and your partner discussed and agreed and maybe even wrote down on a napkin but haven’t properly documented and put your signatures to.

I caution startups from using free agreements from the internet. I’ve reviewed a number of these online documents and they are filled with confusing and sometimes irrelevant language that only serves to complicate the relationship.They also tend to be too broad to address the unique needs of each startup relationship and in most instances, it is also helpful to have an attorney walk you through various alternatives with respect to compensation (which is often deferred during startup phase), equity distribution or vesting periods for founders.

The costs for hiring a lawyer to draft your startup agreements range from $500 – $2500 depending on whether you are already incorporated, the complexity of the issues, number of co-founders and how much negotiation will be needed to reach an understanding; another $1000 for having a lawyer set up your corporation. If you are hiring employees, independent contractors or appointing an advisory board, standard templates tailored for your business — once drafted — can serve the needs of most of your new hires and appointees. Try to negotiate a project fee basis with your lawyer to lock down the costs.

Securing your Assets

Founders agreements are also used to ensure that all intellectual property is assigned and transferred to the company. This can include anything from protecting inventions, trademarks, logos, marketing materials to customer and supplier lists, pricing and so forth). This way, should the partnership break down, you have safeguarded your business assets from future hassles.

 It sounds simple –so, why do so many startup teams go without these essential agreements?

First, no one really wants to rock the boat – and, if you didn’t establish working terms from day one, you may be afraid to bring up critical issues for fear that it could cause the relationship to break down before the company gets off the ground.  Second, founders tend to focus on external threats and don’t make it a priority to spend the money on drafting internal agreements.  Third, you may be unsure of your commitment level and prefer to keep things loose until the business gains traction. Whatever the reason, if these agreements haven’t been put in place, consider the benefits of doing so now.

Asking the Difficult Questions: Are you and your Partner on the same page?

Does one founder see the company as his long-term employer, while another sees the company as a short-term liquidity event?

Is one partner devoting full time while the other is working another job until the business is funded? Is one partner putting in money while the other is putting in time?

Do you have the same or different vision re: the types services or products the company will provide, the company’s growth plan or the role of each founder?

As you can see, critical issues to be addressed are unique as the individuals involved. To get the dialogue rolling, here is an outline of some of the things that should be discussed:

  • The goals each of you have for the startup and for yourselves
  • Duties, job descriptions, and hour commitments
  • Who pays for what? Who gets paid first?
  • Spending authority; budgets; bank account signing authority
  • What happens if one of you wants out; what happens if one of you wants to sell the company, raise capital, or end it?
  • Whether launching other startups, i.e. is “moonlighting,” is ok?

Once you have answered these questions, documenting your understanding is the only sensible way to maintain a healthy working relationship, establish fair ownership and reduce the likelihood of disputes or litigation down the road. If you have comments or questions, please feel free to contact me.

Advisory Boards are Key

The issues an entrepreneur will deal with during the visionary process are vastly different from those they face when commercializing the business and therefore, down the line, partners can disagree on decisions such pricing or distribution strategy, choosing whether to operate the business or license it to a third party.  For this reason, most seasoned entrepreneurs put an advisory board in place. Trusted advisors that you and your partner agree would add value to your business can be called upon throughout the course of growing your business to mediate any disputes amongst founders. You can offer to compensate them in equity or options (depending on their level of involvement, these advisors receive anywhere from 1%-5%) and/or offer payment for each board meeting they attend.

In addition, once you set up your corporation, you will also need to put in place an operating agreement. An operating agreement ensures your LLC is governed by your own rules — not the default rules of your state of incorporation. An operating agreement addresses critical points such as where, when and how often board meetings are held, how many members should be on the board of directors, how profits will be distributed and other rights and responsibilities of those involved in your corporation.

The first 12 months can be make it or break it so– set yourself up for success by promoting a culture of clear communication: address, resolve, document and continue to revisit agreements as roles or commitment levels change.

If you have questions about founder or operating agreements or other startup documentation, send me an email (info@paulabrillson.com) or leave a comment.  I’m happy to answer any questions you have.

Want to read more tips on what co-founders should consider in startup phase, take a look at Deb McAlister’s Blog @ http://debmcalister.com/2012/11/25/5-legal-traps-start-up-founders-should-avoid/

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1 comment
  1. Good article! Good advice! Thanks.

    Steve Robinson

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