Why You Should Have a Co-Founders' Agreement

Why a Co-Founders’ Agreement Is Key To Smooth Startup Operations

November 16, 2020

Try as they might to be realistic and practical, co-founders going into a startup are naturally excited to work on making their dream business a reality. And that positive energy is necessary to motivate co-founders along the sometimes arduous journey of business creation. But once positivity encounters trials or roadblocks, it could be easy to throw in the towel or find reasons that a co-founder should no longer be part of the startup. Disagreements and strife can develop, and frustration could make everyone lose sight of the goal. At Calkins Law Firm we will always recommend that for these very reasons, co-founders opt to tackle potential scenarios upfront, with a co-founders’ agreement.

The Realistic View

A prospective client’s situation – being ejected from the startup he co-founded – made us want to stop and reflect on all the reasons that a co-founders’ agreement is so vital to new business ventures. In the early days of business creation, it is difficult, if not impossible, to fully anticipate the path that the startup will take from launch through eventual exit. It is also true that, at least in our experience, most startups are overstretched and short on cash. Put these factors together and founders may not see the immediate need for an agreement describing something they cannot imagine, drafted by someone they may feel they cannot afford. Some founders may see the importance, but are so cash-strapped that they opt for a home-made or form-based document that cannot fully anticipate and provide for any and all contingencies. But despite what founders may reason, this is not a document to put off or execute half-heartedly. 

Technically, a co-founders’ agreement is optional, but we would not recommend anyone start a business without one, because it protects against the unexpected. As with any legal document, a founders’ agreement must be accurate. It is best to consult a lawyer or a firm to help in drafting one. 

Importance of Having a Founders’ Agreement

If we are honest, a co-founder’s agreement is a substantial piece of work. And admittedly, drafting this document for a startup is no small or easy task, even for an experienced practitioner. But investing that upfront time and effort are key, especially once things with the business really get moving. Without a thorough and complete co-founders’ agreement, many startups will find that as unforeseen disagreements develop, they will need to be resolved after the fact. And without a clear outline for resolution it will be just one more thing on the remaining founder’s already heaping plate of responsibilities.

To put things simply, beginning a new business involves a lot of risks.  Often two or more people come together to apportion a startup. There are a lot of formalities that need to be completed while launching a startup and a co-founders’ agreement is just one of them. Here, as in most places, prevention is better than cure and a solid co-founders’ agreement can help all parties to avoid or resolve future disagreements.  Should business relations not go as planned, a co-founders’ agreement functions like other contracts and acts as a way to legally enforce day-to-day operations and to clear differences in case of dispute. 

By breaking down and assigning liability and responsibility a co-founders’ agreement goes far to establish accountability of all parties involved. Instead of serving as a mere measuring stick, this agreement is a way to make sure that the business is well-handled and also provides a way to recognize achievement and offer commendation. The document can also save the founders from confusion in the case of serious changes in health or finances that make it impossible for a founder to continue holding responsibilities in the business.

Breakdown of Key Reasons To Have a Founders’ Agreement

More than anything else, a solid co-founders’ agreement can align expectations as the business moves forward. Putting a founders’ agreement in place is a good opportunity to speak openly at an early stage about the core, fundamental features of business operations. Ironing out details early on is the best way to avoid future difficulties.

Roles and Responsibilities

Individuals can be assigned to tasks based on their strengths and weaknesses, such as handling operations, marketing, etc.  Each member’s responsibilities are outlined, aiding in the decision-making process and minimizing confusion and frustration.  

Equity Ownership and Vesting

Whether share or equity, founder profits and investments need to be outlined. Allocating ownership among founders ensures that they know where financial matters stand and that everyone is accountable for their part in the business. Do this early to avoid hurt feelings once the business grows.

Exiting Plan

In case a founder wants to quit the startup and start something of their own, the founders’ agreement will outline procedures to follow to keep things fair.

Intellectual Property

The founder’s agreement ensures that IP is safeguarded under the business name. This is key in the case that a founder decides to go their own way and wants to take their ideas with them.

Future Building

A founders’ agreement helps to guide and form future business transactions in a way that best benefits the business itself and the founders involved.

Dissolution

Should the company need to be shut down the founders’ agreement will include a clear plan as to how the company will be dissolved and how share proceeds will be generated.

Contingency Plan

While not enjoyable to think about, unpredictable and tragic situations can develop overnight. A founders’ agreement can provide guidance should death, loss due to underperformance, or a severe accident befall a founder. 

Clearly, there are innumerable factors that company founders need to consider when deciding what to include in their co-founders’ agreement. The end goal of this document is not to create a contract to be weaponized, but to forge a protection – an insurance essentially – for whatever life throws at the company and founding team. When difficult situations arise they are easier to deal with in the moment if clear guidance has already been established. And everyone’s head is far more clear when thinking on these tough scenarios well in advance, without the taint of urgency or heightened emotion. While this process may seem time consuming and could bring up some sore points, once it is drafted founders can move forward knowing that they have done due diligence by each other and the company they are trying to create.

Experienced Experts, Reliable Advice

At Calkins Law Firm we know that launching a business can become a heavy strain on founders. This is why a co-founders’ agreement is so vital. After all, no one can predict what the future holds. But you can take control of the present and decide on some business parameters now, while operations are just getting started. Our team has solid business and legal experience and can testify to the importance of drafting a co-founders’ agreement. Reach out today to learn how our skilled team can help you to plan for and protect against uncertainty. We are honored to assist you in reaching your business goals!

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