Introduction:
In the series of blogs we write, this is our first blog on co-founders agreement. We will attempt to decode all the myths around the founder and the founders agreement. In this blog we attempt to answer 3 basic queries.
Founder vis -a vis a co-founder,, what is a co-founders agreement and the legal validity of a co-founders agreement. This will help readers and especially entrepreneurs to understand basics of co-founders agreement before moving on to understand the clauses that form part of a co-founders agreement.
Who is a founder?
Founder is the mastermind or the one with an idea or vision and wishes to implement such an idea which can provide for something innovative or improvise any area or solve any existing problem. As just an idea is not enough, so for the implementation of his concept or idea which can be by starting a new business or startup, he tries to accumulate resources which can be monetary or intellectual. Further all of these efforts can be for profit or non-profit.
Who is a Co-founder?
A founder for the implementation or materialization of his idea and when he is independently incapable of doing so by himself, may require additional persons either for finance or for specific skill sets. Such a co-founder can be on the same track as his founder i.e. he can also have his share in the founder’s idea and is willing to put equal efforts in implementation of the idea. He is someone who is involved with others assisting in the practical materialization of the founders idea for the creation of a startup or business.
What is a Co- Founder’s Agreement?
A co-founders agreement is basically a formally written agreement between the co-founders of a new business or a startup. It provides clarity with respect to the ownership and terms of business or startup, nature or functioning of a startup or company , initial investments, profit sharing ratio etc. It also throws light on the professional relationship amongst the co-founders, obligations of co-founders, allocations of responsibilities between co-founders and future goals or vision of the co-founders of a startup or company. Further the most important role that a co-founders agreement plays with respect to a business or startup is that it provides for safeguards and protection in case of disputes between the co-founders by providing details with respect to what the co-founders have agreed at the beginning of their company or startup. It provides for an open dialogue or discussion by way of mediation or arbitration between the co-founders thus safeguarding the interests of the co-founders and also saving the company or startup.
Legal Validity of a Co-founders Agreement:
Co-founders agreement is generally signed before the incorporation of a company or startup i.e. before the existence of a company or startup. So it raises doubts as to the legality of a company or startup entering into a contract prior to its existence or registration. In such a situation, the ‘Specific Relief Act 1963’ has provided the remedy. Section 15(h) provides that ‘The specific performance of a contract may be obtained by any party thereto when the promoters of a company have, before its incorporation, entered into a contract for the purposes of the company, and such contract is warranted by the terms of the incorporation, the company: Provided that the company has accepted the contract and has communicated such acceptance to the other party to the contract. Similar remedy has been provided in ‘Section 19(e)’ of the ‘Specific Relief Act 1963’.
The following are some of the important clauses in a co-founders agreement:
1. Ownership: It provides for the ownership pattern of each co-founder i.e. the percentage and number of shares held individually, division of profits etc. This is also crucial in determining the voting rights of each co-founder.
2. Intellectual Property : This is a crucial clause in the determination of the distribution of equity of a startup or company. This clause decides the fate of the intellectual property, brought in by a co-founder or created during his existence, when he wishes to quit the startup or company.
3. Description of Business : This clause defines the potential venture of the startup or company, its objectives and the services it will provide. In this clause, a list of milestones can also be provided which are to be accomplished within a specific period of time.
4. Roles and Responsibilities : This Clause specifies what will a co-founder actually do in a startup or company. It specifies the roles and responsibilities he will play. This clause provides the co-founder with clearly specified pre-decided targets and tasks. Further it is also necessary to keep room for new roles and responsibilities for the co-founders as the startup or company expands with time.
5. Business Decisions: It provides a mechanism through which business decisions of the startup or company can be taken by the co-founders in a convenient way. Decision making power is equivalent to the shareholding pattern of the co-founders in the startup or company. It should not only specify the procedure for taking important decisions but should also specify about taking simple decisions i.e. daily decisions.
6. Induction of New Co-Founders : This clause provides for the procedure to be followed while inducting or introducing a new co-founder in the startup or company. It can also provide for his roles and responsibilities.
7. Loan from Founders : This clause provides details with respect to how the loans from the co-founders are to be treated. It also provides details as to how such loans shall be paid back with interest or through any other benefits.
8. Compensation Clause : This clause provides for reimbursement of costs and expenses incurred by the co-founders in the initial stages of the start-up.mThis may include rewards as well as risks for which provisions should be
specified.
9. Exit Clause : This clause provides details about the procedure to be followed when a co-founders decides to exit the startup or company. It lays down the mutually agreed circumstances under which a co-founder can be removed or fired by other co-founders. This can include fraud and lack of performance. It also mentions the rights enjoyed by the co-founders after their exit. This includes ‘Right of first refusal’ giving an option to certain parties to buy the shares that are being sold by the leaving co-founder before offering such shares to third parties, ‘Tag Along Rights’ gives the other co-founder an option to exit the startup or company on similar negotiated terms and conditions.
10. Non-Compete : This clause is extremely important as it prevents any co- founder, who exits the startup or company, from starting a similar business and thus competing with the original startup or company. These clauses can provide for a specific time period of non-competition like 3 to 5 years.
11. Non-Solicit: This clause requires the leaving co-founder that he does not solicit the clients and the employees of the startup or company he took an exit from.
12. Confidentiality Clause : This clause makes it mandatory for the present co-founders as well as the leaving co-founders to maintain confidentiality and not to disclose any of the sensitive matters of the company or startup.
13. Dispute Resolution Mechanism : This clause provides for a pre-decided dispute resolution mechanism. The issues can be resolved through mediation or arbitration by a pre-fixed mediator or arbitrator. Opting for such ways of dispute resolution can prevent the reputational damage of a startup or company which it risks when it opts for litigation.
14. Termination/Winding Off/Shut down : This clause provides for the circumstances under which a co-founders agreement can be terminated, future course of actions if the business does not take off and becomes unviable like distribution of assets, liabilities and any money left in the business or startup.
Conclusion:
So the short explanation of all the clauses above will help the readers to know the
basic elements that form a part of the co-founders agreement. This will help any entrepreneur or anyone willing to form a startup or company to be more prepared by having a pre-existing knowledge with respect to a co-founders agreement. It also helps him engage more with a lawyer who is well versed in drafting co-founders agreement or a startup lawyer who is well versed in drafting, vetting and negotiation of contracts and agreement relating to startups. In the next blog, we will look at the co-founders agreement of housing.com to further showcase why a co-founders agreement is necessary for a startup or company.
