A Founders' Agreement ("Agreement") is a contract undertaken among a company's Co-founders. The Agreement is a legally binding contract, usually in writing, that outlines the roles, rights, dispute resolution, and responsibilities of each owner in a business.
Importance of a Founder’s Agreement
The Agreement protects each Founder’s interests and to prevent conflict down the line. It provides a foundation for the Co-Founder relationships in the future, the company structure, and what each owner brings to the business. It is essential that no matter what type of business entity structure you have.
It is essential for some of the following reasons:
Some key terms of the Agreement
It is essential to determine the proportion of equity owned by each co-Founder of a company. Such determination considers multiple factors such as monetary investment, experience, existing intellectual property, know-how, and industry network. Such evaluation paves the way for ascertaining the voting power of each Co-Founder.
The Agreement must provide a mechanism to deal with a situation where any of the Co-Founders exits or gets ousted from the company. For this reason, a vesting structure shall be incorporated in the Agreement which details how the shares are divided among the Founders. The vesting structure could be time-based vesting, where Founders get shares in proportion to the period of company tenure. It could also be objective-based vesting, which considers the objectives set out in the Agreement.
The Agreement should also incorporate and assign the roles and responsibilities of each Co-founder of the company. The general demarcation is operations, marketing, administration, and finance.
The Agreement must consider the rights and restrictions of the Founders to transfer their shares in the company. There can be a provision in the Agreement providing for a lock-in clause specifying the number of years before the expiry of which the Co-founder is not permitted to transfer the equity owned by him in the company.
A way to ensure that there is no transfer of equity to outsiders is by providing the right of first refusal to the shareholders. This right requires the Founders to transfer their shares to outsiders only when the other company shareholders refuse it first.
In general business practice, the ideas, inventions, and other intellectual property ("IP") developed by a person remain their property. The Agreement should contain a clause stating, the IP, developed by the co-Founders in the course of business, shall always be owned by the company. In specialized sectors, the Founder can contemplate sharing intellectual property with the company. However, this needs to be well thought out and carefully documented.
The Co-founders may make value additions by bringing in intellectual property rights, technical know-how, marketing rights, or similar value additions in the company. There must be a clear understanding between the Co-founders concerning the nature of such value additions, the monetary value of such value additions, periods at which incorporation of such value additions should occur, and compensation to the Co-founders for bringing in such value additions. On particular occasions, the Co-founders are issued shares against the value additions made by them. The Agreement should lay down the number of shares to be issued, percentage shareholding, and the share valuation method so that there is no ambiguity.
There needs to be an agreement between the Co-founders prohibiting them from engaging in activities that clash with the company objectives during their association, and for a certain number of years after the Agreement's termination.
However, a non-compete clause affecting the cessation of employment would fall within the mischief of section 27 of the Contract Act and void to that extent.
This Article Does Not Intend To Hurt The Sentiments Of Any Individual Community, Sect, Or Religion Etcetera. This Article Is Based Purely On The Authors Personal Views And Opinions In The Exercise Of The Fundamental Right Guaranteed Under Article 19(1)(A) And Other Related Laws Being Force In India, For The Time Being.
