Often, the ‘need’ for a Founders’ Agreement points to deficiencies in the company’s practices around issuing founder equity and maintaining its cap table, or—far worse—to deficiencies in the founders’ ability to effectively communicate with one another. Founders’ Agreements are disfavored by many seasoned investors, and it’s usually wiser to address the underlying issues (ideally with the help of attorneys who are experienced in the needs of venture-backed startups) than to paper over them with a Founders’ Agreement.
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As a startup founder, you’ve probably heard someone—perhaps an advisor, a professor, a friend, or even your co-founder—suggest that all members of the founding team enter into a “Founders’ Agreement” (sometimes called a “Shareholders’ Agreement” or “Partnership Agreement”) for purposes of solidifying your ownership in the company, clarifying the rights and duties of the founders, and providing a roadmap for resolving founder disputes.
While those are all important objectives, we recommend other, better ways to address them—ways that will save your company money on avoidable legal fees, while helping you and your co-founder remain aligned, and sending the right message to prospective investors. We’ll show you how!
Objective #1: Clearly Spelling Out The Founders’ Ownership & Shareholder Rights
One key aim of a typical Founders’ Agreement is cementing your ownership in the company and your rights as a shareholder. That’s certainly something any founder should want.
But here’s the thing: if your company was properly formed, those terms are already in the stock purchase agreement (sometimes called a “common/restricted stock purchase agreement,” “RSPA” or “CSPA”) you signed when you received your shares. Your ownership stake should also be clearly and accurately reflected in the company’s capitalization record (“cap table”).
Additionally, Founders’ Agreements often contain non-standard provisions that conflict with the standard terms of future equity financing agreements—signaling to prospective investors that the company is not getting the best legal advice (and often causing investors to insist the agreement be terminated as a condition to closing an investment round). We don’t think the supposed benefits outweigh the costs here.
The better way to deal with these issues is to:
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Ensure that the founders have executed stock purchase agreements that are tailored for use with startups and have market-standard terms around restrictions on transfer and the vesting schedule of the shares (including any “acceleration” terms wherein some/all shares vest immediately in the event of an acquisition or a founder’s involuntary termination or some combination of those events); and
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Use a professional cap table management service (ideally with help from legal counsel with significant experience in maintaining cap tables for startups).
So long as each founder has signed a market-standard stock purchase agreement and has access to an accurate, up-to-date cap table, then the risks of the founders being on different pages when it comes to ownership are rather slim—and having a Founders’ Agreement not only fails to add value, it actually has the potential to create discrepancies or ambiguities if it’s anything other than identical to the founder stock purchase agreement with regard to the specifics of equity ownership.
While we strongly advise that you involve legal counsel on these matters, online tools like Clerky and Carta greatly streamline the work your attorneys need to do, making all of this much easier (and cheaper) than at any point in the past. It’s a far better solution than a Founders’ Agreement and can save you a great deal of time and money when you’re going through the diligence process with an investor.
Objective #2: Defining the Roles and Responsibilities of the Co-Founders
Another goal of a typical Founders’ Agreement is to clarify the scope of authority and duties for each founder. It’s noble, but not grounded in the reality of most startups.
Of course, the officer roles and the composition of the board of directors should all be plainly laid out in the company’s formation documents—if not, then that’s another structural issue that needs to be dealt with by working with your attorneys to leverage a platform like Clerky to clean up your documentation. And at a high level, the anticipated effort and involvement level of each founder should roughly tie to their share of equity (i.e. if you’re doing 75% of the work, you should get 75% of the founder shares).
But in terms of the day-to-day, the reality is that especially in the early days of a startup, the founders generally benefit from having a great deal of flexibility in terms of their respective roles. Founders often simultaneously wear multiple hats and trade those ‘hats’ back and forth with their cofounder. When founders have good practices around open communication and feedback, they’re able to intuitively figure out what gaps each of them should be filling, and that approach allows the company to be more nimble (and builds trust between the founders), which is essential for startups.
The best way to deal with this issue isn’t an ornate contract. It’s consciously developing a regular cadence for the founders to discuss expectations, pain points, aspirations, prioritization, and most importantly of all: to deliver meaningful, actionable, substantive feedback to one another in a way that’s nonjudgmental and productive. If the founders can’t do that, the company’s prospects are bleak, period. We cannot emphasize this enough. The greatest product idea in the world can’t save you if the founders don’t have a strong, productive feedback loop with one another, that will eventually extend to the team they’re building.
In conclusion, a Founders’ Agreement cannot fix a misalignment between the founders, but open communication, vulnerability, and integrity can. See here for some solid tips on building a rock solid foundation with your co-founder!
Objective #3: Resolving Conflicts Before They Arise
Of all the stated use cases for a Founders’ Agreement, this is the most compelling. Founder breakups are a huge mental and emotional drain and can routinely be expensive as well (both in terms of legal fees and the likely need to pay some kind of settlement/severance to the departing founder). Who wouldn’t want to be able to point to a contract that plainly spells out exactly what’s supposed to happen when a major dispute arises? You could save a ton of time, stress, and money!
The problem is that it’s rarely (READ: never) that simple. We’ve seen our share of ugly founder breakups, and while there are some common themes, the truth is we’ve never seen the exact same situation twice. The facts are always highly context-specific (and often contested as well), and we’ve yet to see an instance where things are so black-and-white that they could have been resolved with a Founders’ Agreement (for example, a typical Founders’ Agreement spells out what happens if a founder is terminated “for cause,” but of course the practical reality is that the fired founder in most cases doesn’t agree that there was “cause” for their termination so the Founders’ Agreement doesn’t help).
But it gets even worse. Not only does a Founders’ Agreement fail to prevent these types of conflicts, it can also send the wrong message to prospective investors. Seasoned investors (particularly those on the West Coast, where Founders’ Agreements are uncommon) may see an agreement like this as a red flag. Coming across it in a data room could signal to them that the founders may not have a good working relationship, or that there is some source of anticipated conflict.
So…Do I Need A Founders’ Agreement?
In most cases, no. What you need is skilled legal counsel experienced with the particular needs of startups, access to good technological tools to optimize for efficiency around equity and related legal matters, and most of all excellent communication with your co-founder.
Most of these issues can be solved by having industry standard documentation in place and good corporate hygiene. When it comes to founder communications, our advice is always to err on the side of over communicating. Even if you think your opinion is obvious, make it explicit. When you have meetings, follow up with an email summary of what was discussed and agreed upon. Put regular time on the calendar for one-on-ones between the founders. Practice giving and receiving constructive/critical feedback. Don’t let things fester. Be a good listener.
Trust us when we say that organically building a strong and resilient interpersonal dynamic with your co-founder is the biggest investment you’ll ever make in your company.
We hope this was helpful, and that following the advice above will help keep your legal fees down and help start your co-founding relationship off on the right track! Want more bottom-line oriented legal advice? Contact us any time for a free consultation to see if we’re a fit for your team!