Documenting arrangements between founders will be a key area of review by any incoming investors and it is also important if and when one of the founders leaves the company. You could leave the drafting of your founders’ agreement until a later date but it is much better to have the necessary discussions and reach agreement at the start to avoid problems later if the founders’ expectations have changed or their attitudes towards the company’s operations have changed.
The beginning of a business journey is an exciting time but it is also the best time for you and your co-founders to ask yourself those tough questions and imagine the worst-case scenarios. It is much easier to discuss the hard issues now while the going is good than to be unprepared in an emergency or if a founder already has one foot out the door.
To help guide you through these conversations, we’ve set out a list of questions for founders to ask themselves in our Article Dear Founders, Please note the following. Love, your Lawyers.
Once you have cleared the air and had those difficult discussions, it is vital that you write them down.
The type of investors that you want to invest in your company are also the type of investors that will expect your company to have certain items in order. Vesting schedules for founders and assignment of intellectual property to the company will be at the top of their list. A Founders’ Agreement can describe the vesting schedules, cliffs and acceleration provisions upon a change of control or a founder exiting the business. Each founder should also assign all intellectual property interests that relate to the business to the company under the terms of the Founders’ Agreement.
A word on vesting
Founder vesting refers to the terms on which a founder surrenders a portion of their shares back to the company if they leave the company within a certain period of time (usually 3 – 4 years). Some founders may expect to receive shares in the company without any vesting constraints because, as they see it, they had the idea, are working on the idea without pay and they own the company. Other founders who accept the need for vesting may try to delay implementing it until an investor (usually a VC) requires that vesting as a prerequisite to its investment in the company.
Why should we include vesting arrangements?
• Accelerators and competitions: If founders have come together for a competition or through an accelerator programme, they have probably contributed only minimal time and/or money to the startup. Asking founders to work in the business for a minimum period before their equity allocation fully vests to them is particularly appropriate in these situations. Similarly, these founders may not know each other well so it is foreseeable that not all of them will remain in the business 12 months down the track.
• Keeping it fair: If a founder leaves your company during an early stage and your company does not have any vesting in place, that founder will own all of the shares he or she was issued. So, the basis on which the ownership percentages were determined no longer reflects the contributions the founders are currently making to the company.
• Diluting ownership: The company will probably need to replace the work the departing founder was providing and may need to issue additional shares or options to the incoming replacement. As a result, other shareholders will experience dilution of their ownership of the company.
• Preventing a jackpot: Under a vesting arrangement, any unvested shares are returned to the company if a founder leaves before his or her shares have vested (often at the same price the founder has paid). This prevents the departing founder from receiving any sort of premium for the shares.
Click here to generate your ScaleUp Founders’ Agreement.
The ScaleUp Founders’ Agreement assumes that the founders have already incorporated a company to carry on the business. If you have not yet incorporated a company, please see our Article We’re going into business together. Do we need an agreement?.