Founders’ Agreement

Ambiguity happens a lot in entrepreneurship. This is perhaps the reason why Singaporeans are not entrepreneurial compared to their foreign counterparts, since they prefer things to be in black and white. Here is a hazy situation which I am sure that most of you (particularly young entrepreneurs) will go through. Suppose you set up a enterprise (which is not officially or legally incorporated) with two friends to build a product/service/innovation, what happens if the following three situations happen: (i) How is the ownership divided among the three of you? (ii) How much decision making power rests on each founder or, who’s the leader? and (iii) What are the deliverables that must be achieved by each founder towards incorporation? This is where a founders’ agreement helps in setting down the rules and regulations on paper. This article helps to set forth some fundamentals on setting up a founders’ agreement.

Once you have decided to enter into a business venture with your team, you need to have a founders’ meeting. This meeting is extremely important because it helps to set up a framework for important issues, for example, equity among founders (as shareholders), decision making capabilities and execution of rolees and responsibilities for the company. If you don’t set this down clear, you will always be learning how to manage your fellow co-founders on the fly. To ensure that things will move properly, one good practice is to have a founders agreement. In some sense, it is an “official” document to help the founders to have some direction towards where they want to go and explain important management processes in the team. After all, if by now, you must understand that everyone works for themselves. If there is no value proposition, even the best teams would not stick by you. Hence it is important to address these questions far in the beginning.

There is no one-size-fits-all document on founders’ agreement. Actually, if I have to do one, it should be just one to two pages long and must address the following questions:

1. Founders’ equity (or shares): This is the most sensitive issue and has to be resolved first. Who gets what percentage of the company? The easy but not the best rule of thumb is to divide the company equally among the founders. In the case of technology commercialization, it is even worse because there is a divide between an inventor and a business development/sales person. One good practice is to put a number of shares and divide among the team appropriately with each milestone achieved. For example, each founder can start with 100 shares valued at $10, and if founder A fulfils prototype A before the corporatization, he will get 500 shares in addition to the number set down. So, if all of the milestones are fulfiled, all of you will end up having equal shares at the end when the company is officially incorporated. It also makes things clean for the investors to put money into the company. If you are lazy, you will just divide the shares equally, but the problem will be when you have a founder who might contribute nothing and get the shares. You might also consider how to pay yourselves when you corporatize your business officially.
2. Decision making powers: Who makes the decision to do something? In a startup, it is better to have a democratic system, i.e. you have votes. It is often good to have odd number teams, because one person can cast the tie break. I have witnessed many cases of team leaders making decisions at the expense of the team members, for example in getting investors, partners and collaborators to the point that the company signs a bad deal. Hence collective decision processes are important to ensure that the team will not end up being divided. It also ensures a fair and balanced discussion. That’s why in the startup stage, the leader is called the interim CEO or better, (s)he doesn’t have a title.This question also resolves the first question. The rule is to create voting and non-voting shares, particularly when you have investors. The best strategy is to create a board of directors, and decide what kind of decisions get made by the board and what do not. Usually, the board should approve strategic directions only, and then the team gets the power to approve management and operational decisions. The issues that come up all the time involve hiring and firing of personel, mergers and acquisitions, equity re-arrangement upon investments, strategic collaboration with big companies or partnerships with another firm and internal company problems.
3. Future plans of founders that are not aligned with the company: What if one of your founders is an undergraduate and decide to work in a multi-national company after two years from now? Then you need to set it down clearly that how the compensation to the team and him works.For example, I had to come back to Singapore after I co-founded the company with the team. However, it would not have been fair that I had equal shares with my fellow founders since they would be slogging hard to keep the company going. So, the best arrangement is that I gave back some of the shares to them (with proper official agreement) so that there is an incentive for them to work on. Here is a way to think of this: there is no point owning 25% worth of shares cost $10 each, but 5% worth of shares cost $1000 each. It is a win-win situation for both sides, because the rest will be working hard and you get to resolve things amicably and burn no bridges.
4. What if one of us are fired in the process: Even co-founders get terminated. This is no laughing matter. One good rule of thumb is to set up the timelines and milestones such that everyone fulfils it and be worthy of a founder status. If these people can’t work well for a common project in the first place, what makes you think that they can start a company officially together? A process needs to be established. For example, you should set down rules that if a co-founder embezzles or do something inappropriate that damages the startup cause, then he or she should be fired with the co-founder status stripped.
5. Roles and Responsibilities, future and immediate goals (milestones): Make sure that you set down the roles and responsibilities for the team. In a startup stage, it is often better not to work by the labels. You can all agree who the point of contact person is, and give each other titles. However, in the execution stage, this is not so clear cut. There are times when you need to help out your fellow team member in another role, so do not set things down so quickly. The best way to do this is to have a set of immediate tasks or goals that each one of you should fulfil. That will also help to assess the team in general. Here are five essential tasks which I always think of when I do a startup: (i) business plan and executive summary, (ii) prototype for the technology ready for customer testing, (iii) seeking investors, collaborators and clients, (iv) business presentation and (v) get your URL and company name/tagline.
6. Exit Strategy: Then you must all have some idea where this will take you. If you are in doubt, consult this earlier blog entry on “Exit Strategy 101 by me.

Once you get the primary issues resolved, there are these secondary ones:

• What are the contractual terms for each founder?: You might want to draft a non-compete agreement, so that your fellow founders don’t take what they do here and replicate it somewhere else. Another similar issue which might pop up for technology companies are non-disclosure agreements. Any intellectual property issues must be resolved at the early stage before incorporatization.
• What fraction of the company’s ownership will you set aside for employee stock options? Why?: Remember that there is a difference between paying someone a salary and giving someone ownership. Most founders don’t earn a lot at the start because of their equity ownership. The reward for any entrepreneur only comes in much later, hence if you are really the money-faced type, my advice for you is not to get involved in a startup, because you need to wait for years to reap its benefits. Of course, higher risk higher returns, that’s the basis to why most entrepreneurs go on their venture.

With all these thoughts, I will let you think about how you should draft your founders agreement. Remember, it has to be straight-forward, short and simple and not filled with too much wiggles to let anyone have too much advantage over the other.

Related Links
[1] Important Questions Startup Co-Founders Should Ask Each Other