20 March 2023
Beginning a new business involves a lot of risks. As a founder, you are risking your investment into a venture by beginning the business and it is only prudent to take all precautionary steps. Usually startups are formed by more than 1 founder and together they work towards building the startup. There are a lot of formalities that need to be completed while launching a startup and a co-founder’s agreement is one of them in order to ensure there are no legal battles needed to be fought between the founders at a later date along with securing each one’s interest to the fullest.
A Co-Founders’ Agreement (“Agreement”), like all other contracts, helps in navigating the founder’s day to day operations and also helps in clearing the differences in case of any issues arising. It also specifies the terms and conditions between the co-founders’ of a startup, regarding how the business will be operated between them and the profit sharing, intellectual property rights and most importantly what happens at the time of termination.
Key Clauses that should form a part of the Co-Founders Agreement
A well drafted Agreement will become the basis of a long and smooth journey of the founders in building the startup and making it achieve the milestones they had hoped for. Some important clauses that should form part of the Agreement are explained below.
i. Capital contribution
The Agreement should clearly establish the contribution that each co-founder will be making in the Company and the percentage of total capital held by each of them respectively. It should also mention the form and manner of contribution in case the contribution is given in a manner other than monetary contribution. The clause should also highlight the manner of calculating the change in the shareholding in case there is an additional capital invested.
ii. Roles and Responsibilities
The roles and responsibilities of every co-founder are different, depending on their skillset and capabilities. It includes specific grounds like decision-making responsibilities for the role assigned to each co-founder. These roles should be laid down in the Agreement to avoid vague assumptions and disagreements at a later stage. The co-founders must declare their roles and duties towards the Company in the Agreement and also lay down the activities of the business for which they will be individually responsible.
iii. Transfer of shares
The Agreement should clearly state any restrictions if applicable on the transferability of shares held by the founders. The lock-in of shares, vesting of shares, right of first refusal or right of first offer (as agreed upon between the founders) in case of any founder wanting to exit from the business and transfer of shares to legal heirs in case of death of a founder should all be covered under the Agreement.
It is extremely essential to incorporate the construct of non-compete clause in the Agreement in order to protect the business and the interest of other founders. There should be clear agreement between the founders about not being eligible to engage in activities that are in conflict with the objectives of the business while they are part of and for a certain number of years post exit. The Agreement should also include what constitutes “conflicting activities”.
Confidentiality remains the prime aspect for the success of any business. The know-how, client information, pricing and future strategies along with any other business related information which if leaked to third parties would cause immeasurable damage to the business all should be protected with utmost care. It is absolutely essential to incorporate confidentiality obligations by inserting the clause in the Agreement thereby binding the founders to maintain adequate and reasonable levels of confidentiality during and after the end of the term of their relationship with the Company.
vi. Intellectual Property
In general terms, any intellectual property, trademark, etc. developed by any employee during the course of their employment belongs to his employer. It is pertinent to note that the co-founders are no exception to this. While each of them brings and contributes their ideas, thoughts, inventions it is important that intellectual property rights are assigned in the name of the business and not remain in the name of any individual. Intellectual property ownership can become a major point of dispute at a later stage. This situation can be avoided by incorporating a properly worded intellectual property assignment clause to ensure that all intellectual property that is developed during the course of the business by the founders, shall always be owned by the business.
vii. Exit process
In the event of the removal of any of the co-founders due to reasons like underperformance or material breach of any responsibilities and obligations, the Agreement should state the manner to be adopted and the exit mechanism. The Agreement should incorporate clauses which provide for when a founder wants to exit from the business and the manner in which the assets will be divided.
viii. Dispute resolution
There is always a possibility of a conflict or dispute between the co-founders amidst running a business. These deadlocks have an adverse impact on the economic value of the enterprise as a whole, and therefore it is important to have a predetermined mechanism to resolve deadlocks. The Agreement should provide for a clear mechanism for resolution of deadlocks. The most common method is arbitration.
Lastly, it is critical to incorporate the commensurate compensation to be paid to each co-founder. The Agreement should contain general understanding between the co-founders on this subject, while their respective employment contracts would provide for specific terms governing their employment. It should also state the profit sharing mechanism as decided between the founders.
x. Other key aspects to be kept in mind while preparing the Agreement should be the voting matters and governance issues in order to make decision making smoother in the long run.
The Agreement forms the foundation of a long lasting and successful relationship between the co-founders leading to the ultimate success of the business. It is essential to incorporate all the relevant details as discussed above along with other business specific details. It is advisable to take the help of a legal counsel to avoid any important aspects getting skipped in the Agreement.
The Agreement serves a dual purpose. It not only establishes a clear relationship between the co-founders but more importantly, it acts as a guiding document for investors to judge the governance mechanism of the business.
The content of this article is for information purpose only and does not constitute advice or a legal opinion and are personal views of the author. It is based upon relevant law and/or facts available at that point of time and prepared with due accuracy & reliability. Readers are requested to check and refer to relevant provisions of statute, latest judicial pronouncements, circulars, clarifications etc before acting on the basis of the above write up. The possibility of other views on the subject matter cannot be ruled out. By the use of the said information, you agree that the Author / Treelife Consulting is not responsible or liable in any manner for the authenticity, accuracy, completeness, errors or any kind of omissions in this piece of information for any action taken thereof.
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