Jun 14,2022 | 7 min read

Co-Founder’s Agreement | Importance | Lawyered

A co-founder’s agreement or a founder’s agreement or a founder’s collaboration agreement, whatever it may be called, are the agreement that governs the professional relationship between the founders who created and started the business together. It is the contract that sets out the ownership in the company, initial capital contribution and duties and responsibilities of each Co-Founder. But the question that arises is why should one consider entering into a separate co-founder agreement in the face of other options like LLP, partnership, company, non-profit entity etc? Here lies the answer that the agreement will safeguard against any future dispute and protect by bringing out what was once agreed between the co-founders.

Initially the co-founder’s agreement may be entered into at the time when they decide to come together since it is extremely important to decide certain issues, which requires clarity on the expectations from each other. These issues involve decisions regarding how much to expand and the capital required, time required to settle down the complete business, allocation of responsibilities amongst the founders, profit sharing and shareholding and deciding upon the intellectual property of the business etc. Therefore there must be some essential clauses that must be drafted and included in the co-founder’s agreement, some of which are:

  1. Business Definition and Milestones: Definition of the potential business or venture of the company is very important and must be drafted in a broad way so as to include every future prospects but must not be vague. The agreement can be drafted for a short duration or upto a certain milestone. 

  1. Economic Interest and Ownership: While defining the current ownership, the risk of non-enforceable agreement can arise and hence requires enforcement, therefore at this stage the parties can either choose to register the agreement with the registrar where the business is situated to ensure its enforceability. In other cases where the parties do not agree to register, they can simply specify the share of the co-founders in future if they agree for the formal setup. 

  2. Intellectual Property and Non- disclosure Obligations: The work related to Intellectual property must be complete and exclusive. If the co-founder leaves the company, he has to relinquish his rights over the codes, layouts, business plans, marketing and financial plans, and any other content created for the business. Such content is solely made for the purpose of the business. No co-founder can disclose the details related to intellectual property to any third party without taking their prior written consent.

  1. Mechanism to Determine Ownership or Economic Interest: The method to determine the ownership or economic interest can depend upon: equal division of interest, division based on interest or the capital contributed by each of the co-founders etc. Ideally, a combination of the above three can be best suited.  

  1. Vesting: Any co-founder agreement for the business with the vesting of the shares can include vesting of shares in the following ways such as: Time based vesting or milestone vesting. 

  1. Roles and Responsibilities: The roles and responsibilities amongst the co-founder must be equally allocated. It is important to discuss them because it sets out clear intentions as to what each of them have to bring to the table. Typically, the roles and responsibilities can be divided into operations, sales, and marketing, administration, finance, etc. 

  1. Decision Making Process: The agreement must include the clear decision making process and a clause regarding it where the voting procedure is mentioned must be inserted in the agreement. 

  1. Performance Criteria and Firing: The co-founder agreement must specifically redress the firing criteria in a broader way. There may be some ways to oust the co-founder who is found not working and create a slack amongst each other while others are working hard. 

  1. Dispute Resolution and Conflicts: In case there is some serious conflict or the breakdown of relationship among the co-founders, the agreement must also mention methods to be adopted for the dispute resolution. One cannot let the possibility of approaching the courts which always remained open. An arbitration clause can be inserted for such situations.

  1. Non Compete Restrictions: The co-founder agreement must include the non-compete clause which restricts the co-founder who exit the firm/ company either on retirement/ leave etc from starting any same business setup upon the same idea. 

  1. Provisions for Compensation: The clause regarding the reimbursement of the expenses incurred by the co-founder of the company personally, must be included. 

  1. Exit Mechanism: The clause regarding the exit mechanism must be inserted in the agreement to define how a co-founder can exit the company, which can also include the procedure to remove a co-founder and the situations pertaining to it. 

 

Conclusion:

Although starting a new company or business can be exciting, the co-founder or the new entrepreneurs must not make the mistake of ignoring important legal things like creating the co-founder agreement and deciding upon the inculcation of the important clauses as defined above.  The benefit of a co-founder agreement lies not only in the fact that it formalizes the relationship between the founders but also in providing guidance on how to deal with roles and responsibilities, commitments as well as any contingencies that might arise in the future.  

 

Keywords:

Co-founder, agreement, clauses, business, venture, economic interest, ownership, Intellectual Property, Non- disclosure Obligations, vesting, roles and responsibilities, decision making process, performance criteria, firing, dispute resolution and conflicts, non compete, compensation, exit mechanism.


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