Everything feels possible when you’re starting up a new business. You have a great idea, trusted co-founders, and everyone is cheering you on. Slowing down to make sure all the legal documents are signed and sorted can feel like an unwelcome delay, but it’s a vital part of making sure you, your co-founders and your business are protected for the future.
A founders' agreement ensures the interests of all owners are looked after and that everyone is on the same track. Here’s more on why you need one and what’s involved.
According to Harvard Business School professor Noam Wessman, 65% of start-ups fail due to co-founders falling out. Quarrels can arise from a number of issues including differing business goals, leadership struggles, and, naturally, money.
One way to avoid an unhappy break-up, and maybe avoid breaking up altogether, is by having an agreement in place that lets everyone know clearly where they stand.
What is a founders' agreement?
A founders' agreement is a legally binding document that states the roles and rights of each business owner and any other important parameters that might come in useful, from organisational structure to equity stake. It’s designed to protect the interests of everyone involved and ensure a fair outcome should any disputes occur further down the line.
You can easily create a founders' agreement yourself. There are plenty of basic templates available online and we’ve included some at the end of this article. However, if you need to be completely certain you’ll be protected from a legal standpoint, you might want to hire a business lawyer or solicitor to help you put one together.
What should I include in a founders' agreement?
A founders' agreement can include anything you like, from sign-off processes to what happens if somebody leaves the business. The elements you choose will depend on what you and your business need now and are likely to need in the future.
Here are just a few things you might want to consider including:
Roles and responsibilities
Include the names of all parties, with their titles and a breakdown of what each role involves. Having responsibilities formalised in writing means everyone is more likely to stick to them.
You may also wish to include the external business interests of each individual.
Even at the very earliest stage, it’s worth committing your idea to paper. What is your business going to do? How will it be different to other products or services already on the market? Make sure you get down all the key details you’d use in a pitch.
Decide and then document the percentage of the business owned by each party. You may also wish to include which owners have a management interest, and which have a purely financial interest.
Deciding on equity split isn’t easy and will be different for every start-up. You’ll need to have open, honest conversations with your co-founders about what makes sense for your company. While an equal split may feel like an easy solution, it isn’t always the best. It’s worth taking into account the commitment of each party, the investment they’ve made and their creative contribution.
You’ll also need to decide what options will be offered if new founders or employees come on board and what happens if somebody leaves the company.
Creating a vesting schedule allows you to allocate shares or options over a set period of time. This mitigates the risk of an individual with a large stake leaving the business and taking all their equity with them.
For start-ups, this period is often a four-year benchmark with a one-year cliff, plus 25% for each year worked. However, successful companies can take much longer to establish. In order to retain talent for the duration, you may decide your company requires a longer vesting schedule.
Some founders may choose not to take payment initially, but for many this simply won’t be a realistic option. Choosing a level of compensation is a difficult decision and will depend entirely on your start-up's circumstances. You may want to consider a vesting schedule (as above), but you may also want to agree on when founders want to cash out, or whether you’ll be taking a salary.
While you need to pay out enough to allow founders to survive, you don’t want to pay so much that they, or you, become complacent.
It might not be the most uplifting part of putting together a founders' agreement, but it’s one of the most important. You need to decide what happens if the company fails. You should outline the circumstances that might lead to the company being dissolved, the procedure that should be followed, and how assets would be distributed. A clear, thorough exit plan will give you security and peace of mind.
These are just some of the elements you might wish to include in your start-up's founders' agreement. If you’re an early-stage start-up you may only need to cover basic information, adding to the agreement as your company grows. As you hire more staff, you might consider expanding the document to include the kind of guidance you’d find in an employer’s agreement, such as absence policies and sick pay.
It’s always worth talking to a trusted advisor when putting your agreement together. You might seek legal advice, as well as more general advice from your professional network. An experienced entrepreneur who has been through the process can help you ask the right questions, consider aspects you may have overlooked, and reassure you that your founders' agreement is a strong foundation for your start-up's success.
Founders' agreement templates
These days it’s fairly easy to find templates online. Here are just a few.
If you’re looking for support and guidance to grow your early-stage start-up, Pitchdrive’s network of business angels is a great place to start. Get in touch with the team today to find out how we can help.