Bada has a startup idea, but she needs a partner to execute it. She has found Toba, who believes in the startup idea. Bada enthusiastically offers Toba the role of co-founder, which Toba accepts. The first thing we advise Bada to do is sign a founder’s agreement with Toba.
A founder’s agreement is a legal contract that governs the relationship of the founders with each other and with the company. It aims to separate the company from the founders and define ownership and responsibility between the founders.
This article will discuss some common clauses founders must consider in a founder’s agreement, and they include:
Shareholding or Ownership Structure
This clause aims to establish the initial proportional ownership of each founder in the company. It protects the startup’s future from ownership disputes that could arise when a co-founder exits the startup.
In determining the ownership structure of each founder, factors such as cash invested, expertise, and network, to name a few, are taken into consideration. Once the ownership structure has been defined, it is necessary that the ownership clause explicitly and unambiguously specify the percentage of each founder’s equity ownership.
Vesting
This aims to protect the healthy longevity of startups, provide a structure for the exit of a founder, and give investors confidence that the startup will run for a long time to protect their investments. In simple terms, it means that founders will earn their shares in the company over a certain period of time. Vesting may be time-based, which is based on time spent in the startup; milestone-based, which is based on the founder’s performance; or hybrid, which is a combination of time- and milestone-based vesting. We advise startups to carefully consider which vesting method is best for them based on their needs and stage.
Duties to the Company
It serves to record the duties and obligations of the founders. The duties of the founders are foundational to the success of the startup. The duties of a founder are also determined by their expertise and time commitment. Hence, the duties of a full-time founder may not be the same as those of a part-time founder.
Assignment of IP
It is essential that founders assign all IP assets developed in the course of their work at the startup. Not only does this contribute to the value of the startup, but it also protects it against any future risks. The clause must be broad enough to capture the what, when, who, and how of the IP assignment from the founders to the startup.
Non-Circumvention and Non-Compete Clause
This clause prohibits the founders from being involved in a startup-related business during their time at the startup and for a period of time after disengagement. For practicality, this clause should not be too restrictive so that it can be enforced. What is deemed too restrictive differs from jurisdiction to jurisdiction. An example of a restrictive non-circumvention and non-compete clause that may not be enforceable is where the restriction extends beyond 2 years; in some jurisdictions, a restriction that exceeds 6 months may be unenforceable.
There are more clauses that founders need to take note of in a founder’s agreement. Some of these include the transfer of shares, management and approval rights, and confidentiality. It is imperative that founders thoroughly understand the meaning and effect of each clause before signing a founder’s agreement.
