Structuring a founders’ agreement
When getting a new enterprise off the ground, there is nothing more important than having a clear agreement amongst the founders around a handful of key issues that are critical to your ability to safeguard the future viability of your new enterprise and to raise venture money. These key issues cover three really important areas: the roles and responsibilities of the founding team, equity ownership and vesting and IP ownership.
While there is no agreement over exactly how, there is widespread agreement over the value of forming some sort of agreement among company founders — sooner rather than later in the life of the company.
The power of these sorts of agreements may be as much a function of the conversations that are had in order to put these conclusions into place as it is a function of the formal agreement/document itself. The goal of the conversation/agreement is to have an open and honest discussion of the attitudes, fears, and aspirations of, as well as the arrangements among the individuals involved with the startup in the hopes of minimizing the likelihood of debilitating surprises later in the life of the company.
This note will focus on four key issues that are common to these agreements: ownership, responsibility, decision-making, and operating procedures. Sometimes, the matters of decision-making and operating procedures are bundled into a single issue. More formal and legally binding versions of these founder agreements will undoubtedly address a range of subjects in addition to the four discussed below.
Roles and Responsibilities
The matter of roles and responsibility to the venture involves answering the questions of what each individual will do, for what they might be responsible, and to what extent they might be responsible (particularly in terms of time). While it can be common for founders to play broad roles in the early days of a firm, it can still be beneficial to designate the more significant role any individual might play.
Designating Founder X as responsible for managing the finances of the firm will not, necessarily, reduce that person’s role to only the finances of the firm. This designation, however, can help support the condition that when torn between two tasks-one of finance the other of development-this individual should focus on and take responsibility for the finances while another individual should focus on and take responsibility for development. The roles that founders play may change over time. Therefore, this initial designation of role/responsibility should not prove to be unchangeable. Instead, build into the decision-making procedures the means for redefining roles.
Decision-making / Operating
An important feature of this agreement covers the method through which both simple and substantial decisions should be made. In other words, which sorts of decisions can be made by a single individual and which sorts of decisions should be voted on by the group of founders. If a vote occurs, does everyone have an equal vote (regardless of their proportion of equity) or shall voting procedures align with the distribution of shares. In the case of a split vote (50% on one side of the decision, 50% of the other) will anyone have the deciding vote? If so, how is that person determined and how shall that decision be made?
One truly uncomfortable decision that should not be left uncovered revolves around the “firing” of any of the founders. If three people are involved, the risk always exists that two founders might organize and vote out the third. If possible, consider and define those circumstances under which you would all agree that the ouster of a founder ought to be on the table. Beyond raw voting procedures, founders might desire to explicitly state certain values or other factors that ought to be considered when making decisions.
Certain subjects of decision-making, such as hiring/firing employees or buying equipment, may be considered so likely to occur or likely to occur regularly – that the founders may wish to just explicitly agree to their preferred course of action rather than vote upon each instance of these common issues. Alternatively, the operating procedures in the agreement might be so intertwined with the decision-making components that the two dimensions would be dealt with as if the same.
The question of ownership is, at the most basic level, a question of who owns how much of the initial equity in the company. That said, this equity-based measure of ownership can also signal—explicitly or implicitly, intentionally or unintentionally—opinions about who’s decision carries the most weight, and who’s actions contribute how much to the value of the venture.
Any attempt to determine the “best” way to divide ownership at the outset of the firm’s existence is most likely futile. A web search on this subject, however, will make it clear that the experience of futility has not prevented many people from believing that some “best way” does or might still exist.
Instead of shooting for the perfect split, consider the question of “Why?” and “Under what conditions?” when determining who gets what. Furthermore, leave some room for your inability to get this slitting challenge perfectly correct. Spare yourself the agony of the optimization attempt. Assume some best split might exist, but that ideal can only be known in a world of perfect foresight or unlimited do overs. Since we don’t live in that world, we might as well act accordingly.
The founders of nonprofit corporations will not likely find themselves daunted by the issue of ownership of the firm, given how the assets (or the value of the assets) of these firms ought be distributed under federal or state laws. The conditions of employment, rewards, and credit will still apply, however.
Contributions of effort or capital
Another method for splitting ownership involves a consideration of effort and/or capital (whether financial, intellectual, social, or some other type) that has been or will likely be contributed by the founders. An advantage of the capital/effort contributions method is that it can more directly address the subtle subject of “fairness”, if not the more concrete subject of contributed financial capital.
A limitation to this method can be your capacity to anticipate whether future contributions of ideas, effort, and even capital will conform to the initial designation of equity. Furthermore, the conversation around the value of different types of contributions-like ideas and connections-can, at times, get at least slightly complicated if not very contentious.
Vesting or milestoning
You have more flexibility in the initial ownership decision, however, than some concrete designation of ownership from day one. Vesting simply involves the right of the firm to buyback shares contingent upon certain described conditions.
Conditions that might determine the grant/buyback of shares could include such factors as: the passage of time, the accomplishment of certain tasks, or the occurrence of certain events. In fact, many vesting agreements condition these rights upon the passage of time.
Departure and dis-ownership
One dimension of ownership that can be but should not be overlooked is the issue of departure — the course of events that unfold if someone decides to leave the venture. Vesting and milestoning features in an agreement address the issue of departure, in part, by conditioning ownership according to time spent with, or things accomplished for the firm. What an individual might do with their shares upon departure, however, is not addressed through vesting/milestoning conditions. You may choose to restrict whether or how a departed founder can sell their shares.