A significant consideration as a company co-founder is the rights and responsibilities of each founder. The primary way in which to do so is a co-founder agreement, a key legal document that outlines important parameters regarding equity, liability, intellectual property rights and obligations of each founder. In general, a co-founder agreement regulates matters that are not considered in the company constitution. This article sets out four key issues co-founders should consider when drafting their co-founder agreement.
1. Dividing Equity and Vesting
Allocating equity (shares) between founders is one most important and delicate aspects of a co-founder agreement. Although a typical scenario, it does not always have to be equal and should preferably be allocated on the basis of factors such as the time commitment and capital investment the founders will commit to the business. It is also common to leave a percentage of equity free to assign to future hires.
Equity allocation details are usually located in the schedule of an agreement, so as to allow details to be changed more easily in the event a founder was to withdraw from a company or another founder was to come onboard at a later time.
Once the split is finalised, the issue of vesting, basically the mechanism used to describe at which point a founder is entitled to claim that equity, should be taken into account. It is advisable to vest so as to ensure the founder’s long-term commitment to the growth of the company. For founders, a four year vest with a one year cliff is common for most startups. Meanwhile, for external advisors, 0.5-2% equity is common, with a two to four year vest and optional cliff. When shares are tied to a ‘cliff’, this means the individual must be with the company for a year to vest the first increment. While one year is common, you could use any time period.
- How will the equity be split amongst the founders?
- How will equity vesting work? What is the vesting schedule?
2. Intellectual Property
Intellectual Property (IP) encompasses the expression of ideas, information and knowledge. In a company, IP can include contributions, inventions, discoveries, creations, developments and ideas. Intellectual property should be assigned to the company rather than the co-founders themselves. The same applies to intellectual property developed by the company’s employees, and great care should be taken to convey this to all parties involved. Often a co-founder agreement will set out that IP is irrevocably assigned, including all right, title and interest in the project. Clauses classifying what is confidential information and the circumstances in which it can be disclosed, should also be worked into the agreement.
- What intellectual property will the company be creating?
- Will all intellectual property be assigned to the company, even when a founder works in his or her own time?
- Do all founders agree not to disclosure confidential information to competitors?
3. Roles and Responsibilities of Founders
A co-founder agreement, especially ones that are entered into by startup founders, will typically establish the business’ operations and the roles and responsibilities of founders. It is a priority to make apparent which areas of business operations and the responsibility such oversight entails, that founders will be charged will managing. This serves to ensure that founders are accountable for their actions in their agreed functions. It also lays the groundwork for what positions, for instance Chairman and CEO, the co-founders may eventually take as company directors. On this point, it is also vital to establish who has decision-making power over what in order to preserve trust if a disagreement occurs. This delegation is often made in light of what skills founders bring to the table and who is the most qualified to have on the subject of a particular matter.
Once these capabilities are defined, the co-founder agreement then needs to lay out the appointment/removal mechanisms, privileges and duties of the Board of Directors. The roles of the management team them should also be articulated in a similar fashion.
- What will be the specific responsibilities of each founder?
- How much time will each founder put into the company?
- What capital contributions will be made by each founder?
4. Resolving Disputes
One of the primary measures to prevent disputes from arising is sale or transfer clauses. Most commonly these encompass “right of first refusal” “tag along” and “drag along”. These are incorporated into an agreement to ensure that safeguards are in place should a founder want to sell or transfer their shares, something that will typically have direct consequences to other founders. The functions of each are outlined below.
Right to First Refusal: If a co-founder wishes to sell their shares to a third party, the other co-founders in the company are entitled to buy the shares at the agreed rate with the third party.
Tag Along: Protects minority co-founders by giving them the right to be bought out at a rate proportional to that at which a majority co-founder chooses to sell out at.
Drag Along: Serves to stop minority co-founders from prolonging a sale the majority shareholder is undertaking, effectively compelling them to sell along with them.
- What dispute resolution processes are there in place to resolve disputes?
- What happens if a founder decides to leave the company?
A co-founder agreement is a legally binding document that requires due attention and planning ahead. Co-founders should look to identify and talk through any issues that might appear in the future and prepare contingencies around these. As such, a robust co-founder agreement is a key document in mitigating the high-risk surrounding startup ventures. If you need a co-founder agreement drafted, get in touch with LegalVision’s startup lawyers.