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Founders’ Agreements – A Quick Guide

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by Startacus Admin

Founders' Agreement
Katie Philipson
, Senior Associate at Stevens & Bolton, LLP runs through the key details of a Founders agreement, why you might need one and what should be included in the agreement itself.

Katie PhilipsonWhat is a Founders’ Agreement?

The terms Founders’ Agreement and Shareholders’ Agreement are often used interchangeably. Essentially, a Founders’ Agreement looks to establish the basics, such as the roles and responsibilities of the founding team, equity ownership and vesting and IP ownership. A Founders’ Agreement is a form of shareholders’ agreement suitable at the early stage for the founders and will typically be replaced by a more complicated shareholders’ agreement when the business takes on more shareholders or external investment. 

Do I need one?

You can start a new business without a Founders’ Agreement and wait until you start to scale up before putting detailed agreements in place. However, the absence of a Founders’ Agreement can leave your business exposed and it can be much harder (and more costly) to navigate difficult issues if they arise.

What do I need to think about including and why?

As a business owner this is not a simple question. It often requires a fine balance between obtaining necessary protection for your Founder Agreementbusiness and reducing the scope for disputes, whilst allowing for the effective management of a growing company and avoiding unnecessary legal costs. 

Entering into a business with someone will give rise to significant expectations around commitment of time and attention. What happens if things don’t go to plan? What if you fall out with your business partner? How can you protect yourself and the business?  You may find your partner steps back and leaves you running the business, whilst they reap the rewards of your labour. Worse still, you could find that your partner walks away and competes using the business’ knowledge and experience.

If you focus on these issues at the outset you will better prepare yourself and your business. Whilst company law provides some rules for corporate governance and administration, it does not fill the void that is left by not having formal agreements in place.

So, how do you go about addressing this?

Identify potential issues and discuss them

By considering potential issues and discussing them openly with your business partner you can form a clearer idea of whether (and how) to proceed. There are many potential sources of tension:

  • The founders failing to grow with the business, perhaps becoming bored or disillusioned with the rate of progress.
  • Disagreement over the direction of the business or whether to risk capital investment rather than growing organically. 

Discuss potential issues openly and honestly. Specific areas to think about include:

  • The management and decision-making at director and shareholder level, including how deadlocks will be resolved;
  • How the business will be protected: service agreements, restrictive covenants, intellectual property ownership and confidentiality obligations;
  • Whether you need a dividend policy or will leave payment of dividends to the directors’ discretion;
  • Whether different classes of shares are needed;
  • Whether (and how) new shares can be issued, existing shares transferred and whether there will be pre-emption rights;
  • The rights (if any) that shareholders have to financial, and other, information; and
  • What will happen in a sale – can a majority of shareholders oblige a minority to sell, and can a minority tag along with a sale by the majority?

Invariably entering into agreements at an early stage with dove-tailed articles of association that are well-structured can prove hugely beneficial. The precise form of agreements may be driven by issues such as confidentiality, the number of parties, any external funding received and any expectation of a future change to the shareholders resulting from transfers or new investment. 

Founders Agreement
Think about the future – is external investment imminent?

Whilst a Founders’ Agreement should be in place at an early stage, it is likely to need to be replaced as the business grows and takes external investment. If external investment is imminent it may be worth pausing before putting agreements in place, as the form of investment could dictate the structure of a new shareholders’ agreement, particularly around the provision of regular detailed financial information or perhaps even board representation. 

If you’ve decided to have a Founders’ Agreement, are there any pitfalls to avoid?

There are very few disadvantages to having agreements in place. However, those that do exist often arise from having agreements that are not suitably tailored to the business or which lack precision. Being overly prescriptive can stifle a business, whilst an imprecise agreement can lead to disputes.   

Caution and suitable advice are therefore essential as a properly tailored Founders’ Agreement gives founders a firm base for their business relationship and the future growth of their company and will hopefully help avoid disputes.

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Published on: 27th November 2018

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