Want to start a business and run it successfully? Look no further, because we at LexStart would assist you in de-tangling the ‘startup maze’.
LexStart recently organised a webinar on ‘How to start and run a business?”. The session was conducted by our Co-Founder and Legal expert Ms. Anisha Patnaik, who holds more than 16 years of experience in the legal field and has been part of the growth journey of many startups during her illustrious career. In the Session, Ms. Patnaik provided her valuable insights on the nuances of starting and running a business. Many diverse topics were discussed, but the key takeaway was the requirement of a co-founders’ agreement. Ms Patnaik touched upon the various aspects of a co-founders’ agreement starting from why is it required to what are the key clauses required in the same. We give you a sneak peek into the discussion around the co-founders’ agreement, through this blog post.
Do you have a Co-Founders’ Agreement?
Before you decide to commence your business, make sure that you enter into a Co-Founders’ Agreement with all your co-founders. This agreement would determine the key elements of partnership before you commence business.
When should you enter into a Co-Founders’ Agreement?
A co-founders’ agreement would essentially outline the co-founders’ roles and responsibilities in the entity being set up. Hence, it is ideal that you enter into such an agreement at the time of the initiation of the relationship i;e preferably the ideation stage, incorporation stage or the capitalization stage. Make sure that you have a written and signed co-founders’ agreement, before you commence business.
What should you include in a Co-Founders’ Agreement?
Equity investment and capital structure
When you start a business, you decide on the equity investment and the capital structure. Terms related to these should be captured in the co-founders’ agreement. Specifics such as : what is the nature of equity being invested, what is the capital structure, what is the vesting schedule etc. should be ideally included.
A co-founders’ agreement should clearly demarcate who has what role and responsibilities. Pertinent details such as composition of the board, veto powers, the procedure through which deadlock situations may be resolved etc. need to be included in a co-founders’ agreement.
Include clauses which would enable the co-founder to exit the entity. Exit can be on the basis of non-performance or resignation (early exit). You can provide for the option of reverse vesting, wherein if a co-founder exits, he shall have to sell his shares to the other co-founder/s.
Transferability of shares
A co-founders’ agreement should lay down the processes and ways through which the shares of the company may be transferred. A right to first offer (if a co-founder is exiting, he would have to compulsorily offer the other co-founder his shares before he can offer to anyone else) and a right to first refusal (co-founder has the right to refuse the offer of shares and it is only after such refusal that the shares can be offered to a third party) should be built in the contract. Ensure that the shares are not sold to a competing entity.
Ensure that the co-founders are locked in for a certain period of time. There should also be a lock-in restriction on the sale of shares. For instance, if you enter into a co-founders’ agreement, you would not be able to sell your shares for a period of six months, or exit for a period of six months. This period of six months is called a lock-in period.
This clause is the soul of your co-founders’ agreement. Make sure to impose a contractual restriction on the co-founders that they cannot join a competing entity after they exit from the company for a stipulated period of time. Similarly, a restriction preventing them from soliciting the company’s employees/customers should also be imposed upon them.
Event of default
You and your co-founders should determine a list of events whose occurrence would trigger a default. For instance, one of the co-founders was also involved with a competing entity, this would amount to an event of default.
Would an Oral Agreement Suffice?
No, do not enter into an oral understanding. It is always preferred to have all the terms and conditions governing the relationship of co-founders captured in writing. It is also advisable that you enter into a co-founders’ agreement at the incorporation stage when some amount of time and money have already been invested. Do not confuse an employee with a co-founder. Make sure that when the stake is split all past and present contributions are taken into account.
To summarize, a co-founders’ agreement is a prerequisite of starting a business. If you want to be adequately protected and want all the terms and conditions captured in writing, you need to have a co-founders’ agreement. There may be a substantial bit of negotiation on a co-founders’ agreement and it is important that all the co-founders agree on the terms and conditions. Hence, it is advisable that you approach a lawyer to draft and negotiate a co-founders’ agreement on your behalf.
Want to draft a co-founders agreement and do not know where to start? Just contact us at firstname.lastname@example.org and we would provide you with a free checklist.