When you start a new business with partners or co-founders, there are a number of key issues to address in a formal partnership agreement or co-founder agreement. Discussing and addressing these issues at the beginning can avoid problems and conflicts later on, and it can help ensure that all parties are in alignment about how the business will be operated.
As a preliminary matter, the business should not be started as a general partnership, as that can result in liability of the partners for the debts and obligations of the business. It usually makes more sense to start a new business as a corporation or a Limited Liability Company (LLC). (See LLC vs. Corporation: Choosing the Best Structure for Your Startup.) My personal preference is to avoid an LLC and start the business as a corporation.
Here is a list of key issues to address in your agreement:
1. Capital Contribution. How much money or property will be put up by each founder at the start of the business? Will one founder provide services instead? Will the contribution be a capital contribution or a loan to the business? What happens if the business needs more money to operate down the line—is each founder obligated to put up to a certain dollar amount?
2. Percentage Ownership of the Business. What percentage of the business will each founder own at the outset? Percentage ownership does not have to be equal, and one founder who comes up with the idea for the business or the bulk of the capital will often expect to get 50% or more. The percentage ownership could change over time as new capital is invested into the business, either by the founders or outside investors. What percentage ownership approval of the founders will be necessary to allow new capital contributions by the founders or new investors? Should the founders’ stock be subject to vesting based on continuing participation of the business for some period of time? Without vesting, a founder could leave right away and still own all of their shares, which may be acceptable if that is the business deal among the founders, especially if a founder paid cash for their shares.
The parties should also consider reserving 10% to 20% of the stock to be granted to future employees, especially in the case of tech companies trying to attract and incentivize employees.
3. Intellectual Property. You will want to make sure that if any founder is bringing intellectual property to the business (such as inventions, patents, business plan, business concept, code, etc.), that it is properly transferred to the company and owned solely by the company. And as a prudent matter, all founders, employees, and independent contractors should sign a Confidentiality and Investment Assignment Agreement for the benefit of the company. (See Key Issues with Confidentiality and Invention Assignment Agreements with Employees.) This will ensure that any intellectual property developed by company employees and contractors working for the company will in fact be owned by the company. Any future venture capital investors will be particular mindful of this.
4. Titles and Roles. What are the titles and roles of the founders? Typical officer titles are Chief Executive Officer, Chief Financial Officer, Chief Technology Officer, Chief Marketing Officer, and Chief Strategy Officer. Is the role of each founder part time or full time? Specificity is important here. You don’t want one partner expecting to work 10 hours a week and the other partners thinking he or she would be working 50 hours a week. And who will be on the Board of Directors of the company? And how can roles be changed over time? Should the founders have employment agreements setting forth the terms of their employment and how they can be terminated from employment, with severance benefits spelled out?
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5. Compensation to the Founders. What salary and benefits will each founder be entitled to for their role in the business? Will that be payable currently or deferred until the business is past the early stages, so as to preserve capital?
6. Decision-Making for Key Matters. How will key decisions be made and with what approval of the founders/shareholders? How will day-to-day decisions be made (the CEO is typically authorized to make day-to-day business decisions). Major matters may require approval of 51% or 75% in interest of the founders or shareholders. Major matters could include taking on new capital/investors, selling the business, changing the bylaws or charter documents, taking on substantial debt, change in the number of directors, etc.
7. Withdrawal from the Business. What happens if a founder no longer wishes to be active in the business and wants to pursue other activities or retire? Will the company have the right to buy back his or her shares, and at what price? Will there be some restriction on competing with the business after withdrawal (this gets tricky as some states don’t allow non-compete clauses)? What happens if a founder dies? (The estate would typically inherit their shares).
8. Distributions or Dividends. If the business becomes profitable, how are distributions or dividends to be determined? This is typically left up to the Board of Directors of the company. It may make more sense to keep the profits and reinvest in the business rather than issue dividends.
9. Transfers of Stock. What restrictions will there be on a transfer of a founder’s stock to a third party? Will the other founders have a right of first refusal on transfer of that stock?
10. Dissolution or Sale of the Business. The agreement should prescribe what steps should be taken to legally dissolve or sell the business. What percentage ownership vote will be required?
11. Amendments to the Agreement. What type of vote is necessary to change the founder agreement? Some changes may only require a majority vote and some may require a unanimous vote.
12. Dispute Resolution. How will disputes be handled by the parties? My personal preference is to require confidential binding arbitration between the parties before one arbitrator. This can avoid lengthy and costly litigation that becomes a matter of public record.
A solid co-founder agreement helps you avoid future problems
A well-thought-out co-founder agreement spells out the roles, responsibilities, and rights of the founders of a startup business. The agreement can be the key to avoiding misunderstandings and provide for a manageable dispute resolution process. You can’t just get a “template form” online and plug in names. You have to write it with your specific situation in mind, with the help of a startup lawyer or credible online legal assistance service.
Copyright © by Richard D. Harroch. All Rights Reserved.
About the Author
Richard D. Harroch is a Managing Director and Global Head of M&A at VantagePoint Capital Partners, a venture capital fund in the San Francisco area. See all his articles and full bio on AllBusiness.com.