Starting a business is an exciting journey, but it’s also filled with complex decisions. Among the first critical steps for co-founders is drafting a founder agreement—a document that sets the foundation for your business partnership. A well-crafted agreement helps prevent misunderstandings, safeguards intellectual property, and ensures clarity about roles, responsibilities, and equity, which are crucial for startups looking to thrive in a competitive market.

Why a Founder Agreement is Essential

Every startup needs a solid foundation to avoid common legal pitfalls that can arise between co-founders. A founder agreement not only clarifies each founder’s rights and obligations but also minimizes the risk of disputes that could harm your business. From determining how equity is distributed to protecting intellectual property rights, having this agreement in place is essential for tech startups and small businesses alike.

Because it is a legal contract, the agreement is enforceable in a court of law. This means it should be meticulously crafted to ensure that it comprehensively covers all bases and adheres to relevant laws.

• Importance of TIming Options: Founders agreements are best drafted at the inception of a business. Aligning this document with your business plan ensures that every co-founder is on the same page from day one.

Key Elements of a Strong Founder Agreement

1. Equity Ownership and Vesting
Determining equity ownership is often a contentious issue for founders. How should shares be allocated among co-founders? Should equity vest over time to encourage commitment? A robust founder agreement outlines equity stakes and includes vesting schedules to align long-term interests. For example, equity distribution clauses often include a four-year vesting schedule with a one-year cliff.

2. Roles and Responsibilities
Co-founders often bring unique skills to a startup---whether in technical development, marketing, or fundraising. Clearly defining roles and responsibilities avoids confusion and ensures that each founder knows their duties. This clarity can also make your startup more appealing to investors who value operational efficiency.

• Beware of Not Defining Roles Early: Failing to establish clear roles can lead to inefficiency and resentment. An anecdote from a startup founder illustrates how undefined roles resulted in one person handling everything, which eventually led to the company being sold.

3. Intellectual Property (IP) Ownership
For startups, intellectual property is one of the most valuable assets. Your founder agreement should specify that the company owns all IP created during the partnership. Such clauses are especially important for startups working with proprietary technology or branding.

• What If the IP Gets Sold?: Outline the process for selling IP, including who makes the decision and how proceeds are distributed. This clarity helps avoid future disputes.

4. Decision-Making and Dispute Resolution
What happens when co-founders disagree on a critical decision? A founder agreement should outline the process for resolving disputes, whether through majority voting, arbitration, or mediation. Including these terms upfront helps avoid disruptions to your business operations.

5. Exit Strategies and Buyout Clauses
It’s not uncommon for a co-founder to leave before the company has fully matured. A good founder agreement anticipates this scenario by including buyout clauses or mechanisms for redistributing equity. These clauses ensure stability even during challenging transitions.

When a co-founder departs due to reasons such as death, disability, bankruptcy, or being fired, it’s crucial to have a clear plan in place. Here’s how to navigate the situation:

• Buyout Options: Provide remaining members the option to buy out the departing member’s interests. This approach helps maintain control and stability within the company.

• Setting the Buyout Price: If your company is still young and determining a buyout price is challenging, consider setting a price now or using fair market value at the time of the buyout. Rely on an impartial third-party appraiser to ensure a fair valuation.

• Payout Terms: Clearly outline how the buyout would take place and the terms of the payout. This clarity prevents future disputes and ensures a smooth transition.

• Valuation Mechanism: Since predicting the company’s future value can be difficult, establish a mechanism for valuation. This proactive step allows for flexibility and fairness, accommodating the evolving nature of a startup.

6. Initial Capital and Additional Contributions
Detail each founder’s contributions, whether cash, property, or services, and how future contributions will be handled. Collaboratively determine the fair market value of non-cash items, and record this valuation in the agreement to maintain transparency. Decide if contributions are a one-time affair or if they will recur over the life of the company. Finally, clarify terms regarding non-refundable investments. This ensures transparency about the financial commitments expected from each co-founder.

7. Management and Legal Decision-Making, Operating, and Approval Rights
Specify who has the authority to make key decisions and their voting rights. This section should also address the potential for veto rights or supermajority votes, ensuring a clear governance structure.

8. Salary and Compensation
Salary and compensation are key factors that can impact both financial sustainability and team morale. Early-stage startups often require sacrifices, with founders taking little to no salary to direct funds toward growth. However, as the company scales, compensation should be adjusted to reflect financial milestones and personal needs.

Benchmarking against industry standards ensures fairness and competitiveness, while aligning with investor expectations helps prevent future conflicts. Compensation should also be structured based on each founder’s role, expertise, and contributions, ensuring fairness in workload distribution. Additionally, balancing cash salaries with equity incentives fosters long-term commitment, making clear vesting terms essential. Lastly, founders’ personal financial obligations should be considered to create a compensation structure that supports sustainability without burdening the startup’s finances.

9. Taxes and Legal Obligations
Given the complexity of tax obligations, it’s wise to consult a professional to draft this part of the agreement. Clearly outlining tax responsibilities and legal obligations helps prevent future issues as the company grows.

By incorporating these comprehensive elements into your founder agreement, you create a solid foundation that can help guide your startup through its early stages and beyond. This structured approach safeguards both the business and the personal relationships between co-founders, setting the stage for long-term success.

10. Dissolution
Planning for a startup’s end is just as important as preparing for its success. Dissolution clauses outline the conditions that trigger a company’s closure, whether by mutual agreement, financial insolvency, or the expiration of a fixed term. Termination clauses specify how individual founders may exit—whether due to voluntary departure, breach of agreement, or termination for cause. A well-drafted agreement also includes winding-down procedures, covering asset liquidation, debt settlement, and the fair distribution of remaining assets.

Drafting The Founders Agreement

If you are a Talking Tree subscriber, follow the instructions in the video below to learn how you can create a founder’s agreement that meets the above criteria.

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If not, these steps will get you started on the right path:

1. Choose a Template: Begin by selecting a template that aligns with your startup’s needs. Templates are widely available online and can serve as a solid foundation. You can also use ours at Talking Tree under Free Resources. Feel free to customize by combining elements from various templates.

2. Fill Out the Basics: Start with the straightforward sections. Enter information such as names, locations, and company details that don’t require much deliberation with your co-founders.

3. Discuss the Complex Topics: Dedicate time to discuss and resolve challenging issues like equity, compensation, and termination. These conversations are crucial, so approach them with the understanding that while they may be tough, they’re vital for protecting everyone’s interests.

4. Seek Guidance: Once your draft is ready, have it reviewed by a lawyer or legal technology. This step ensures that your agreement is not only comprehensive but also safeguards all parties involved.

5. Gather Additional Feedback: Consider sharing your agreement with fellow entrepreneurs or advisors. Their insights, drawn from personal experience, can highlight areas you might have overlooked.

6. Review and Sign: After making any necessary adjustments based on feedback, allow each co-founder to review and sign the agreement. Ensure that a digital copy with all signatures is stored securely for future reference.

Common Pitfalls to Avoid

Relying on Verbal Agreements Verbal agreements between co-founders may seem sufficient during the honeymoon phase of a startup, but they often lead to disputes. Always formalize agreements in writing to protect everyone’s interests. If an issue arises after the co-founders have already drafted a Founders Agreement, draft an addendum to ensure all important issues are covered.

Overlooking Future Scenarios Startups evolve quickly, and so should your founder agreement. Be sure to include clauses that account for future scenarios, such as new co-founders joining or additional funding rounds.

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Article by Talking Tree, your legal companion in the startup world. Talking Tree is a legal education and resources platform, including a suite of AI-powered tools crafted by ex-FAANG and AmLaw 50 lawyers, designed to help improve accessibility of legal know-hows and quality legal services. Affordable and user-friendly, Talking Tree helps your company automate routine legal tasks so you can focus on what you do best—building something amazing. Because legal doesn’t have to be boring or expensive. Let’s make law accessible together.