Why a Founders’ Agreement Could Be One of the Most Important Documents

Ben Rashkovich

Ben Rashkovich

Content Strategy Manager at Fundera
Ben is the resident wordsmith and grammar guru at Fundera. He makes sure their top-notch content stays accessible, interesting, and useful for small business owners. Previously, Ben wrote for the Columbia Spectator and eBay's curatorial team.
Ben Rashkovich

If you’re an entrepreneur with that golden, once-in-a-lifetime idea, it can feel impossible to hit the brakes. The name of the game is momentum—slow down, and you’ll miss that window of opportunity, right?

But sometimes you just have to press pause, take a deep breath, and make sure you’re not missing anything big before moving forward. All of those legal documents and agreements you’ll need to draw up are a good example: if you speed on past them, you might regret it down the line.

In other words, you should focus on building a solid foundation before taking the next step with your business. And if you’re planning to run your business with co-founders, then a founders’ agreement is pretty much the perfect place to start.

What is a Founders’ Agreement?

Let’s play a quick game—if you don’t know what a founders’  agreement is, just take a wild guess.

Ready? Go ahead.

Okay, great. Was it something along the lines of, “It’s an agreement… About the business… Between the founders”? If so, then yup, you’re completely right. And while precedent and expectations have set some standards for what usually goes into that agreement, it’s a pretty flexible—and casual—document. But how so?

First of all, we might define it as “A clear agreement between founders on a number of key issues that their business might face.” So, in other words, it’s not a legally-binding contract—it’s just a written agreement. That means you can treat it as a baseline for how your co-founder relationships will work, how your company is structured, and everything else we’ll talk about. It’s not the definitive be-all-end-all statement of your business.

And second, it can be specific without limiting you. It’s understood by lawyers and entrepreneurs that a founders’ agreement is an initial assessment of how things stand when the business is young. If circumstances shift slightly later on, it’s not that big of a deal. It’s a negotiable document, and liable to change. But it’s the ideal place for you and your co-founders to think through any potential problems you or your business might face—and to brainstorm solutions for the future.

If a founders’ agreement isn’t as legally binding as some other documents you’ll be dealing with, does that mean it’s less important? No, not at all. It might not be binding, but a well-done founders’ agreement will protect you in case of a dispute later on. You’ll be able to point back to the founders’ agreement to explain why you did this or why your co-founder shouldn’t have done that.

And sure, it’s optional—but why would you ever choose to run a business without one? Your founders’ agreement is your insurance against the unexpected and the I-hope-this-never-happens. Don’t hurt yourself down the line by skipping an important step upfront! Drawing up a founders’ agreement is best done as soon as that sparkle in your eye becomes an actual business plan: when things progress from “I have this idea” to “Let’s actually do this,” you’ll want a founders’ agreement drawn up. And if you’ve passed that stage already—better late than never.  You can’t predict the future, but you can control the present.

Anatomy 101: Founders’ Agreement Edition

Now that we’ve got what a founders’ agreement is generally, we’ll take a closer look at its bits and pieces. What actually goes into a founders’ agreement? What will you need to discuss with your co-founder as you’re writing one up? What big decisions do you need to make before moving forward with your winning business idea?

Let’s find out!

The Name Game

The founders’ agreement names the founders and the company they’re agreeing on the rules for.

This might seem pretty basic—because, well, it is. But that doesn’t mean it’s not an important part of your founders’ agreement!

Naming your co-founders should hopefully be fairly straightforward and easy. There might definitely be some complicated cases here, but ideally everyone will be on the same page about who is actually investing their time, energy, and perhaps money into this company.

Naming your business might be a bit harder—but, chances are, this isn’t the first time you’ve discussed the issue. And if it is, then you’ve got a fun conversation ahead!

Finally, you’ll want to clarify how long the founders’ agreement will remain valid for, as well as a way for all parties involved to willfully dissolve the agreement. Don’t forget to add in an escape hatch, in other words: you never know what’ll happen down the road. The founders’ agreement isn’t going to legally bind you to continue working for your business forever, but even if you’re incredibly passionate and excited now, you should consider the possibility that your life might move in a different direction eventually. Prepare for every fork in the road, just to be sure.

Squad Goals

This can definitely change as your business changes and grows, but it’s a good idea to get—in ink and on paper—what your company’s goals are. What products do you offer? Which industries are you operating in? What does your business look like to a consumer, a competitor, or an employee? What sorts of plans are you open to trying?

Maybe you’re a software-as-a-service business that plans on adding new major features every three months, or maybe you’re a mint chocolate cupcake bakery that will only ever sell mint-chocolate cupcakes. Either way, predicting and recording how you want your company to operate is an important step—though, again, not legally binding, so don’t worry if you end up pivoting your business model!

This could also be a good place to list your company values, work culture, and so on. What are your priorities? What’s the bigger picture?

Roles & Responsibilities

Even if you run a tight ship of a small business, not every decision should be up to every co-founder… As much as it might feel like the opposite, especially if you’ve only just started your company.

The fact of the matter is that divvying up roles and delineating responsibilities early on lets you avoid confusion and redundancy. Two co-founders might both want to tackle every part of their business, but a CEO and a CTO? Not so much. Making sure everyone knows what they need to be doing means that you’ll have a less wasteful, more efficient business. The more specific you can get, the clearer it will be whether Bob is making unique contributions or reworking well-trodden ground. Cut costs and time sinks as much as possible, especially in your early days.

Of course, that doesn’t mean you need to abandon teamwork, transparency, and communication. In fact, by establishing distinct roles and responsibilities, you’re making it as easily understandable as possible who gets the final say on which things, and which other aspects of your business should be determined by consensus.

For example, maybe John is the expert marketer and Susan really knows how to make a pizza—should they both have to look at every advertisement that John runs in the local papers, or will that just stop them both from doing the work they need to be doing? You’re saving time, energy, and emotions by agreeing to these processes early on.

Finally, you’re creating a system of accountability—if something doesn’t get done, you know who’s to blame. Likewise, if things do get done, you know who to congratulate! Accountability isn’t just a way to measure whether employees (or co-founders) aren’t working hard enough: it goes both ways. You’ll be able to adjust compensation, or even equity, depending on performance.

To sum up: Your founders’ agreement should describe what the co-founders are called, what they do, and how decisions get made.

Equity Breakdown

The co-founders of a business will naturally want to share the business itself—that’s the basic idea behind equity. But how do you divide your company’s equity among its co-founders? Deciding in your founders’ agreement will help you dodge misunderstandings, hurt feelings, and potentially worse.

First of all, you’ll only want to split up about 80-90% of your equity—it’s better to save at least 10% for future hires and other circumstances.  

Second, you’ll just need to have a long and serious discussion about the method and distribution of your shares. There are plenty of ways to do it, but there’s no one right way—it depends on your partnership, your business, and your personalities and contributions.

For example, some co-founders might just want to split the equity evenly between themselves. Others might want to distribute them according to the roles and responsibilities (which we discussed earlier!), or according to who fronted the most cash to get the business on its feet. Maybe you’ll give a bigger percentage to the person who came up with the idea in the first place, or to the one who coded the first demo or made the first batch.

Up to you. There’s no right or wrong answer—only a solution that you’ll agree with, and plenty that you won’t. But it’s way better to have this conversation in the beginning, when a heated argument can cause an impasse and possibly endanger the business getting born at all… Because the alternative is crashing and burning later on, when everyone has more skin in the game.

Vesting Schedule

You’re probably starting to see just how useful a specific founders’ agreement can be by now, huh? By laying out all of these financial details as early as possible, you’ll prevent any serious emergencies that a disagreement down the line might cause.

We can’t talk about equity without talking about vesting: if co-founders got their shares all at once, there would be nothing stopping half of them from hitting the snooze button and letting you do the work. By creating a vesting schedule—often four years with monthly installments—you’re encouraging everyone to earn their keep. Plus, investors will expect a market-typical vesting schedule, and not having one wouldn’t be a great sign.

Treat this section of your founders’ agreement seriously: it can have substantial consequences for your business. Check out some templates online and set aside time to have these talks with your co-founders.

Intellectual Property

Intellectual Property is the creative material that goes into setting your business apart from every other business. That includes your products, recipes, marketing materials, logo, branding, packaging, website, business plan, theme songs, inventions, and more. Needless to say, your intellectual property is important to protect—and the founders’ agreement is a great place to do just that.

First of all, you should make sure that any intellectual property developed for your business goes to the entity itself, not to any particular person. For example, say one of your co-founders comes up with a great new recipe or procedure. If your founders’ agreement states that any intellectual property devised for the business, during work hours, is owned by the business and not any co-founder or employee who came up with it.

Ideally this would never become a problem, but suppose someone decided to break away and form a successful competing business—all because of an invention he came up with while working with you. Protect yourself—and your intellectual property!

Second of all, you’ll need to decide what constitutes intellectual property for your company. Anything the co-founders create, relating to the company, during work hours—that’s an easy one. But what about a co-founder on vacation brainstorming new ideas? Or an employee having her own lightbulb moment? If something was written in the “notes” section of a company phone, is it the business’s intellectual property? You might feel inclined to be hard-nosed about this, but that’s not necessarily the best approach.

Third of all, you should outline the terms for selling off your intellectual property—which may or may not include the terms for selling off the entire company—in your founders’ agreement, too. Who has the authority to make that kind of decision? Where does that revenue go? These are just a few questions you’ll want to answer ahead of time.

Finally, considering discussing non-compete clauses and confidentiality agreements, too. Should a co-founder be able to own stock in competing companies? Or consult for your greatest adversaries? Or spill your deepest secrets? Of course not—and, hopefully, this is never a problem for your business. But the whole point of a founders’ agreement is to be prepared, so even if you trust your co-founders more than your own grandmother, don’t give them an easy out in case things change without you realizing!   

“I’m Making What?

Again, the salary and compensation part of the founders’ agreement is pretty basic—but incredibly important. Noticing the trend? We tend to overlook discussing these fundamentals when the entrepreneurial gears are spinning, but writing up a founders’ agreement forces us to address these topics… And clear up any mismatched expectations everyone could be bringing to the table.

It’s up to you how in-depth you want to go. You can create a thorough compensation plan that accounts for future growth, or you could just deal with present circumstances. Either way, setting a baseline will help you avoid unpleasant surprises.

Plus, this isn’t a bad place to consider figuring out how co-founders can use company money (or not!), whether they can own stock in the competition (and how much, if so?), and who approves investments or debt (and what the processes are).   

Termination Clauses

Finally, a founders’ agreement should go over the circumstances of termination: what happens when a co-founder has been consistently underperforming, and needs to be let go?

Remember that while all of these conversations might feel awkward to bring up, they protect every co-founder equally. No one is exempt. The issues dealt with by a founders’ agreement are unfortunately not uncommon, and every good partner will understand the need for this kind of preparation.

That said, termination clauses can definitely be the most stressful topic to make a decision on. What would you want to happen if your co-founder flunked out on you? What would you want to happen if you were underperforming and dragging the business down? Or, alternatively, what happens if someone just wants to leave—for whatever reason they might have?

You’ll want to figure out what happens with unvested shares, especially. Often a company will have the opportunity to purchase those shares back from the founder at their original price, but that procedure is in your hands, too. Just setting up a system to deal with termination will go a long way—especially if that termination isn’t a friendly one and attorneys are brought into the picture.  If that’s the case, your founders’ agreement—even though it’s not quite legally binding—will show that everyone previously agreed on a precedent in writing. That’s a powerful defense in the eyes of the law.  

How to Make a Founders’ Agreement

Excellent—now you’re a founders’ agreement pro. You know the ins-and-outs of what it’s for, who it’s for, and what separates a good founders’ agreement from a not-good founders’ agreement. (Detail, forethought, critical thinking and actual effort!)

Except for one thing: how do you make the dang thing?

We’ve broken it down into 8 easy steps.

1. Find a template

Let’s be honest… If you don’t know how to do something, the first move to make is “Google it.” Someone else has already figured it out, so why reinvent the wheel?

Drawing up a founders’ agreement is no exception. There are plenty of templates available online for you to peruse. Choose the one you and your co-founders like the most, or create your own with the best bits from each template you find.

Don’t stress out about the finalized language or legalese—you’ll be taking your founders’ agreement to a lawyer before you’re through. Just focus on getting all the important pieces together in one document!

2. Fill out the easy parts

Names, company name, addresses, company address, phone numbers, date of inception, state and country… All that easy stuff shouldn’t take you too much time or energy to fill out.

Finishing off the quick work first sets you up for the next step and will get you invested in your founders’ agreement—you’re less likely to forget about it or prioritize other business matters more. Don’t procrastinate with your founders’ agreement! Like we said, the earlier you can get these issues settled, the better off your business will be.

3. Have the hard talks

Now that the easy-peasy is out of the way, you and your co-founders can sit down and have the serious discussions we brought up before. Compensation, equity, vesting schedules, roles and responsibilities, termination clauses—get it all nailed down here and now, so there’s never a procedural issue later on. (Wishful thinking, maybe… But your founders’ agreement will help!)

You and your co-founders might totally jive right away and agree on every point—or you might wind up compromising on even the smallest details. It’s hard to predict, and these aspects of running your own business tend to run very personal. It’s important not to shy away from any topics, so just be honest, tactful, thoughtful, and collaborative.

Once you’re through, record that admirable progress in your founders’ agreement. The toughest part is now behind you!

4. Make sure to work together

This isn’t a next step as much as a make sure you’re doing this right. Have you really had those serious discussions with your co-founders? If they weren’t aware of a founders’ agreement before, did you properly explain its importance? Were you collaborating or pressuring everyone into agreement?

Now is the time to double-check yourself and be clear that everyone is one the same page. The last thing you want is head to a lawyer and find that your co-founders have no idea what’s going on.

5. Visit the lawyer

Time to visit a startup attorney! They’ll help you understand what your founders’ agreement is lacking, what might be wrong with the template you used (or the changes you made), what could bite you down the road, and all that.

Lawyers aren’t free, of course, but it’s well worth shelling out some of your business capital to insure yourself and your company against some easily prevented mistakes in the future. Defer to the professionals in this case, because they’ll be the ones involved if something serious happens later on.

6. Ask fellow entrepreneurs

Once your lawyer looked over the founders’ agreement, you might want to send it around to a few trusted entrepreneurial friends. If you or your co-founders feel uncomfortable with sharing compensation and equity, you can always black-out those sections. Often another small business owner’s personal experience—whether from a friend or an Internet blog—can help you predict some cases that a lawyer might not have seen. Make any changes you need to make from everyone’s advice, and sit on your decisions for a bit to see how they settle.

Also, make sure to let your fellow co-founders know that you’d like to send out your founders’ agreement for peer review before doing so. This can be sensitive material for some.

7. Formalize and Finalize

Bring the founders’ agreement to your lawyer once more and have them change your template language into fully fledged legalese. You won’t want to touch it after your lawyer has given their stamp of final approval, so make sure it’s not missing any sections or clauses.

8. Sign!

This is the moment you’ve been waiting for! Once you and your co-founders sign your founders’ agreement you should make copies and scans, save them on your computers and file them in the appropriate places, and cross off that big task in your to-do list.

***

Congratulations! You’re one step closer to running your own small business, following best practices along the way.

A founders’ agreement might not seem like the most crucial or exciting part of being an entrepreneur, but it’s incredibly important—and fruitful. You’ll learn a lot about your business, your co-founders, and yourself along the way.

Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.
Ben Rashkovich

Ben Rashkovich

Content Strategy Manager at Fundera
Ben is the resident wordsmith and grammar guru at Fundera. He makes sure their top-notch content stays accessible, interesting, and useful for small business owners. Previously, Ben wrote for the Columbia Spectator and eBay's curatorial team.
Ben Rashkovich

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