Crafting Founders’ Agreements: A Comprehensive Guide
What is it?
Depending on the stage of a business, Founders’ Agreements can be distinguished into two types:
A “Founders’ Pledge” - refers to the agreement made soon after incorporation when the founders have yet to pay themselves a salary; or
A “Founders’ Service Agreement” - describes the same document, created after the founders have begun paying themselves; this will usually only occur after the company has secured its first round of funding. This type of agreement is carefully scrutinised by investors and forms an important part of the company's due diligence.
Why have one?
Although there is no legal requirement under UK Company Law to draw up a Founders’ Agreement, doing so provides a great deal of security and protection for both the company and its founders.
The key reason for entering into a Founders’ Agreement is it certifies the business relationship between co-founders. Co-founders will already be in a fiduciary relationship of trust and confidence, but a Founders’ Agreement allows for certain clauses or points of agreement which would otherwise not be included in the company constitution or other agreements to be decided upon from the outset.
The idea of a business relationship turning sour is seldom considered at this exciting and early stage. Yet, a Founders’ Agreement is an important starting point for a business, for the same reasons that a prenuptial agreement is considered an important document at the outset of a marriage. Rarely do the parties to a marriage expect there to be a breakdown in their relationship - the future is too full of promise for either party to want to prepare for failure using a legal contract. Addressing difficult issues at the outset of any kind of relationship is often in the long-term interests of the parties involved.
The Founder’s Agreement acts as a fallback in case a conflict arises between the founders. Often, it is the strain of starting and then growing a startup that causes a rift between its founders. Sometimes, a collapse in the personal relationship of co-founders (perhaps as friends or family) will cause tensions in their business relationship as well. Regardless, a Founders’ Agreement may help pre-emptively deal with such issues.
Disputes are also made less painful for the founders if they have agreed on what should happen in such an event. Furthermore, the intentions of the founders are clear for all to see in the written agreement.
What Should be Included In a Founders Agreement?
Each agreement should be tailored to its individual circumstances. The following is a non-exhaustive list of issues that may be considered:
Business Idea
What is the product or service the business is providing? what sector will it operate in?
What is envisaged for the future of the business, and what are the timescales involved?
2. Equity Compensation and Vesting
What is the product or service the business is providing, and what sector will it operate in?
What is envisaged for the future of the business, and what are the timescales involved?
Are shares to be issued to the founders unconditionally, or are they to be subject to a vesting schedule?
If a founder joins the company after the initial allocation of shares, how will their equity in the company be dealt with?
A “vesting schedule” specifies when a founder will become absolutely entitled to each of their promised shares. The purpose of delaying the vesting of shares is to incentivise each founder to commit to their involvement in the business, for several years, or after contributing towards major company milestones.
The way vesting usually works is by issuing shares which entitle the company to buy them back on demand. A founder is allotted (issued) all of their shares, with the company’s right of buy-back, expiring over time on set proportions of shares (in accordance with the vesting schedule). Should a founder resign at an early stage, the company may take back ownership of the relevant shares allocated to them.
3. Contributions
This expresses what each founder is expected to bring to the business, which could come in the form of capital contributions, know-how, experience, equipment, premises or existing intellectual property.
Are each founder’s contributions reflected in their salary and/or equity compensation?
4. Salary
If founders are to be salaried employees, at what stage in the company growth cycle can they expect to begin earning a wage?
5. Roles and Responsibilities
What is the day-to-day role of each founder going to be, and how will they contribute to the overall success of the company?
Is the founder also going to act as a formally-appointed director of the company?
6. Restrictions
Are the founders restricted from working on business of a similar nature, outside of the company?
Non-compete agreements: Do the founders agree not to offer their services as an employee to a competing business?
Likewise, do the founders agree not to establish a competing business of their own? Can this restriction endure for months/years after they exit the company?
7. Signature
Each and every founder of the company will need to sign the agreement, confirming that they have read, understood and agreed to be bound by its terms.
The difference between Founders’ Agreements and Shareholders’ Agreements?
The terms ‘Shareholders’ Agreement’ and ‘Founders’ Agreement’ are sometimes used interchangeably to describe any private agreement between the owners of a business. In reality, there is a technical difference between the two, which is worth reflecting upon.
A Founders’ Agreement will usually be created as a precursor to a later Shareholders Agreement. The owners will be at a stage where they are keen to create some certainty about their respective roles, but are not yet ready to flesh out the complex details required of a well-drafted Shareholders’ Agreement.
When Should You Create a Founders’ Agreement?
A Founder’s Agreement should be drafted in the very early stages of a new business venture. For a proposed company, this should ideally be prior to incorporation.
The founders should anticipate that their agreement will be supplemented (or even superseded) by a more detailed agreement between the owners, at a later date.
The creation of a Founders’ Agreement should not be delayed simply because the founders have yet to decide on the details of how their business will be governed, or even simply the legal medium that will be used to run it, as these details may be able to be implemented later on.
The startup advice website “Seedlegals” features a template for creating a Founder’s Agreement; this can be produced at no cost as part of their 7-day free trial. Founder & Co-founder Agreements & Founders Pledge | SeedLegals.
However, legal templates should be looked at with a grain of salt - while they are a useful tool in understanding how a document works, they are not tailored to your situation or circumstance, which a Founders’ Agreement will often require. It is always better to seek bespoke legal advice. For more information on legal document templates, check out our previous article here.
- Author: Edward Bennet-Gibbon
- Author: Edward Bennet-Gibbon
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DISCLAIMER
This article has been written by law students for the sole purpose of providing informative insight. The information in this article is intended for educational purposes only and does not constitute legal advice, nor should the information be used for the purpose of advising clients. You should seek independent legal advice before relying on any of the information provided in this article.
Sources
Noelle Baquiche, 'Free Founders' Agreements for UK Startups' (Seed Legal, 15 February 2019) <https://seedlegals.com/resources/free-founders-agreement-for-uk-startups/> accessed 8 November 2022
Millie Johnson, 'What Are Founders' Agreement' (Rocket Lawyer, 7 October 2022) <https://www.rocketlawyer.com/gb/en/quick-guides/founders-agreements> accessed 8 November 2022
Harper james, 'Why You Need a Founders Agreement' (Harper James, 15 July 2020) <https://harperjames.co.uk/article/why-you-need-a-founders-agreement/> accessed 8 November 2022
