Three Essential Elements of a Founders’ Agreement

Three Essential Elements of a Founders' Agreement

A well-drafted founders’ agreement is key to ensuring a smooth startup journey.

The relationship between co-founders can make or break a business. On the one hand, taking the co-founder route can improve the chances of your startup’s success. On the other hand, it can also lead to disagreements and conflicts. 

In his book, best-selling author and Harvard Business School professor, Noam Wasserman, claimed that 65 percent of high-potential startups fail due to conflicts among co-founders. Typically, the conflicts have to do with money management styles, personality styles and conflict resolution approaches.

To find common ground, you should always draft a founders’ agreement in the early startup stage. It should state each founder’s roles and responsibilities, expectations as well as equity ownership. A founders’ agreement is a legal contract signed by all the co-founders of a firm. The agreement keeps all members aligned and prevents disputes.

Now that you understand the importance of a founders’ agreement, let’s look at the essential elements of the agreement.

Equity ownership

One of the primary elements of a founders’ agreement is equity allocation among the co-founders. The equity ownership percentages must be clearly stated from the start. Ideally, ownership percentage should be determined based on various factors, like capital contribution, experience, resources, etc. The share of equity granted can also have a direct impact on the voting rights of a founder.

Michael Seibel, the CEO of Y Combinator, recommends equal equity splits among co-founders. “I believe equal or close to equal equity splits among founding teams should become standard. If you aren’t willing to give your partner an equal share, then perhaps you are choosing the wrong partner,” he says.

While equal division of equity is the most common approach, there is no hard and fast rule around this. In general, the equity split should be done on the basis of what the person is bringing to the table.

Roles & responsibilities

Each co-founder brings different skill sets, expertise and experience to the business. Overlapping roles and responsibilities might bring about disputes, which can harm business development. To avoid such disputes, the assigned responsibilities of the founding members should be clearly written on the agreement. 

According to Bala Vissa, Associate Professor of Entrepreneurship at INSEAD, the financial success of a new venture depends heavily on who does what within the founding team. “The most successful start-ups allocate positions based on prior work experience as well as how co-founders fit into the social context around them,” he says.

Intellectual property assignment

Intellectual property is a set of intangible assets belonging to a company that could be a brand name, logo, idea or design. These intangible assets differentiate a startup from its competitors and drive revenue. Hence, it is crucial to protect your intellectual property rights during the initial days of your startup journey. 

The founders’ agreement should clearly state who will own the intellectual property rights, company or the founder. Typically, obtaining intellectual property rights in the company’s name seems like a viable option for startups, as the exit of a founding team member may disrupt your business growth. If the IP is unassigned, then the co-founder leaving the startup can claim ownership of it.

Header image courtesy of Unsplash

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