July 23, 2018

Legal Corner: The Founders' Agreement – A Prenup For Your Business

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We know that lawyers often get a bad rap and that many entrepreneurs are fearful of engaging with them. Many entrepreneurs think that lawyers are prohibitively expensive and are not financially viable, therefore put them at the bottom of their priority list.

Entrepreneurs can be so focused on the development and growth of their start-ups, and so sure of their product or service, that they tend to address the more immediate issues of funding or product development while overlooking the legal risks that their organisation may face down the track.

The failure statistics are alarming and access to quality legal services is often a key factor in a start-up’s failure. When money is tight, entrepreneurs may resort to Dr Google (downloading unsuitable contract templates off the internet) or avoid spending precious cash on expensive lawyers. With early legal decisions having a significant impact on the safeguarding of a business as it scales, overcoming “lawyerphobia” early on in a company’s development can prove crucial to a start-up or SME’s success.

Don’t become another statistic. There are a number of things that can, and do, go wrong for entrepreneurs without proper legal support. In this article, we’re focusing on documenting arrangements between founders as this will be a key area of review by incoming investors and will also be important if one of the founders leaves the company.

 

Clear conversations

The beginning of a business journey is an exciting time. It can often feel like the only way is up, nothing could possibly go wrong, and you and your fellow founders will be friends forever. This is precisely when you and your co-founders must 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 the relationship between co-founders has soured and a founder already has one foot out the door. Discussions between co-founders must be both objective and honest and consider the current situation and future scenarios for the business and its founders. The following questions will help get you started:

  • What are the roles and responsibilities of each of the founders?
  • What happens if one of the founders wants to leave?
  • What happens if one of the founders does not want to leave? How can the other founders remove them?
  • How much time will each founder be committing to the business? Both on a day-to-day basis and also looking at the long-term horizon.
  • Who owns what percentage of your company?
  • Will each of the founders contribute some initial seed capital to the business? If so, will these contributions be equal?
  • How will you make strategic decisions about the business? Will everyday decisions be made differently?
  • What is each founder’s overall ambition for the business?

Once you have cleared the air and had those difficult discussions, it is vital that you write them down.

 

Founders’ Agreements

Many new companies fail to establish a well-written Founders’ Agreement that explicitly outlines duties and obligations of each partner. When there is more than one founder, a Founders’ Agreement is crucial for solving of issues that may arise in the future. It is also important to ensure that your company obtains all the legal rights to own or license the intellectual property the founders have created and which is vital to running the business. This intellectual property can be assigned to the company under the Founders’ Agreement. Intellectual property rights will be a key area of focus for any investor doing due diligence on your company, so it is important to get it right from the start.

 

Looking ahead – what do investors want to see?

The type of investor that you want to invest in your company is also the type of investor 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.

 

Avoid mistakes, not lawyers

Putting in place a Founders’ Agreement early in your company’s development will involve some time and cost. But this investment in your company’s future can end up saving you a lot more of both down the road.

 

Hannah McKinlay is a Principal at Support Legal, the go-to and most innovative legal services platform in the Middle East and Africa. We use streamlined practices, technology and a disruptive mindset to bring innovation to a traditional industry. Unlike traditional law firms, we do not charge our time by the hour. We provide cost-efficient and cost-certain legal services by working on a fixed-fee basis or via our unique subscription model. Think of Spotify or Netflix but for legal services. Our team is comprised exclusively of the top 1% of lawyers in the world, each with a minimum of 10 years’ experience with the world’s pre-eminent firms and we have ‘Uber-ised’ access to them. Off the clock and on your side. Welcome to Support Legal. Same Law, Different Thinking. www.supportlegal.com

Topics: Legal Corner, Company Setup, Entrepreneurship, Regulatory Compliance, Startups

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