Cofounder Agreements: the most underrated document in the startup ecosystem
Cofounder agreements are perhaps the most underrated document in the startup ecosystem.
It is not uncommon for a startup to be reluctant to spend money on lawyers in the early stages. Why spend money on drafting agreements when there isn’t any money coming in yet?
But antagonism between cofounders can be the difference between the failure or success of your startup. According to Noam Wassermann, author of The Founder’s Dilemma, 65% of startups fail due to founder conflict.
That’s where a cofounder agreement comes in.
Think of it this way: you can’t wake up one morning and decide to climb a mountain without first investing in proper mountaineering equipment. Without mountaineering equipment, you’re just setting yourself up for failure. For co-founders of a startup, a cofounder agreement is the equipment required to safeguard your company’s success. A cofounder agreement puts cofounders on the same page from the outset. It keeps the company on track when disputes arise, sets out founder roles and responsibilities, and provides clarity about how certain situations should be handled.
Ideally, a well drafted cofounder agreement will resolve founder disputes before they even happen. It will also protect the interests and rights of each party to the agreement and prepare your startup for stronger growth.
Whilst a cofounder agreement is not a requirement for startups, investing in a well drafted cofounder agreement now could wind up saving you thousands of dollars in legal fees down the track.
Key terms to include a cofounder agreement
| Roles and responsibilities | Your cofounder agreement should outline which company function falls under each founder’s area of responsibility. This might include allocation of titles, a description of roles or a statement that roles are subject to review. Roles and responsibilities should be clear and distinct.
It is also important to define who holds final authority within different aspects of the business. For example, critical decisions such as key hires or raising capital should be accounted for. The absence of a decision-making path can lead to conflict. |
|---|---|
| Allocate equity |
Equity allocation refers to the percentage of ownership and control that each cofounder has in the startup. Equity allocation amongst cofounders is one of the most critical and delicate aspects of the cofounder agreement. It is not always the case that each cofounder will (or should) receive equal ownership.
Factors to consider when allocating equity include: |
| Vesting | Allocation of equity in the company may also include a vesting schedule. A vesting schedule will detail when each cofounder receives full rights in the company shares, they have been allocated. In other words, it requires cofounders to ‘earn’ their equity.
A vesting clause will stipulate the conditions before equity ownership becomes available to the founder. Usually, this will be a time-based vesting clause which ensures that founders work for a set period of time. |
| Intellectual property rights | Your cofounder agreement should also deal with intellectual property rights. This will address issues such as whom the product or business idea belongs to and what happens if that person leaves the company.
Logos, trademarks, designs, business plans and source code are all intellectual property. You will need to decide whether the intellectual property belongs to the individual cofounders or to the company itself. Importantly, signing intellectual property rights to the company will increase the value of the company. Ultimately, an intellectual property clause should protect your startup should a founder leave and wish to make a claim. |
| Leaver arrangements | Your cofounder agreement needs to consider what will happen when a founder decides to leave the company by selling or transferring their shares. Clauses such as first right of refusal, tag along rights and drag along rights give other founders an option to deal with exiting founder shares. This will help prevent disputes in the event of a founder exit. |
| Confidentiality rights | Confidentiality clauses prevent cofounders from disclosing confidential information about your startup both during and after their term. |
Cofounder agreement or shareholder agreement?
A shareholders’ agreement is typically focused on the relationship between the shareholders, including investors. It is strongly recommended that you have a shareholders’ agreement in place at the time of an investment round occurring. There is no right time to have a shareholders’ agreement, however in the early stages of your company, it can be a better use of money to develop your product and achieve product/market fit.
A well drafted shareholders’ agreement is one thing investors look for when looking to invest. It is, however, very common for investors to request amendments to shareholders’ agreements to provide the investors with certain rights (such as the right to appoint a director). It can be useful to have a shareholders’ agreement already in place when seeking investment as it shows not only that you are serious but can provide some benefits in negotiating the terms of the shareholders’ agreement.
How can we help you?
Merton Lawyers are experienced in the start-up landscape and provide expert advice to founders in the early stages of setting up their company and raising capital. To discuss how we can assist you, please contact our corporate team on 03 9645 9500 to arrange for an initial consultation.
