Alidad Vakili / January, 2018
What is important to include in a founders' agreement?
Alidad Vakili, Associate at K&L Gates explains why a founders’ agreement is important to avoid disagreements around founders’ responsibilities, vesting provisions, ownership of IP and more.
What is important to include in a founders’ agreement?
Founders’ agreement is really an agreement that will be made by founders that come together when they have an idea to form a company. It’s at the very early stage of a company’s lifecycle and it’s when nothing’s has been created or formed yet, but some folks have a few ideas and they get around the table and talk about creating a company around those.
That agreement is really a critical agreement and it comes at a critical time because once you establish what those rights and responsibilities are, you want to make sure that going forward there isn’t going to be any problems as a result of that. So, we often times will recommend that the parties come together and have the kind of frank discussions you want to have between people that are going to be starting a company. So, who will have what role and what responsibilities in the company, and it’s not always that everyone has to have the same right or say in the company. You might divide it up based on the experience of the people sitting at the table that want to start the company.
For example, you might have someone that comes to the group that has a finance background and he or she may want to be the CFO or treasurer and handle the financial aspects of the company. Whereas another individual is going to be sort of a technical expertise of the company and has an engineering background or design background, whereas someone else might be the business manager because of his or her experience being a manager in various businesses. So, understanding those rules and responsibilities is critical and making sure that that agreement reflects that as well. So, everyone’s role in the company is clear from the very beginning.
Other issues that are important to include are: what’s the ownership will each of them have, what sort of vesting provisions will be provided. Another obviously critical issue is to understand who’s going to have what ownership in the company. Is everyone coming in as an equal owner, are they going to have different ownership percentages and based on what sort of percentages will their role and responsibilities vary to a certain extent, and what sort of vesting provisions will that ownership have.
We typically recommend that for vesting you should really have market vesting terms, so we often times see sort of vesting over four your period with a one-year cliff. It essentially means, for the first year the stock doesn’t invest, after the completion of one year 25% will vest and then the remainder will vest over the next 36 months, usually on a monthly basis. That’s fairly typical of what we see. That’s an important provision to include because you want to make sure that the founders are incentivized and motivated to stay with the startup as it gets going. The worst-case scenario might be if you sign an agreement and everyone gets stock on day one and on day five or month two someone leaves, and they walk away with a stock that they now have vested in fully, and they’re not participating and not helping startup grow any further from that point onward, so it is certainly something to avoid.
The last of sort of the three main areas I think you would want to see the founder’s agreement would be the IP and how are we treating intellectual propriety. So, everyone’s typically coming to the table, some may be providing most or all of the IP or all of the parties may be contributing to it, but it’s really critical to make sure that the company owns the IP and that the individuals creating it, the founders, assign that IP over to the company from the very early stage. Because what you don’t want to have happen is to be in a situation down the road where now you got investors that are looking to invest and as they do their due diligence they find out that while the most valuable aspect of the company’s IP is not own by the company but is really owned by one of the founders, and then that presents a very difficult scenario where that particular founder may have a lot of leverage to demand certain rights in connection with the funding because they still own what is the most valuable piece of that company.
I would recommend starting that discussion about who’s going to have what and how everything’s going to be laid out very early on. The tendency I found with a lot of founders is that they are excited about the business idea and so they’ll rush forward with developing the business and they will put the idea of talking about a founders’ agreement on the back burner. So, I would say that it should be very early on maybe even the first meeting you have there should be an understanding of who’s going to have what role and what kind of ownership. Because that sets the stage for everything that comes afterward and if you have a problem that you don’t address upfront, trying to correct it at a later stage can be extremely disruptive to the company and extremely expensive.