In the last session we talked about finding a reliable co-founder. Now it’s time to make the relationship legal for multiple reasons, which we will be talking about in great detail. Startups usually have countless iterations and pivots as you keep building, and it is very necessary to always legalize this partnership with a Founders' Agreement.

Is a Founders’ Agreement necessary?

You might have known your potential co-founder for ages as friends, colleagues, peers, acquaintances, or just about anybody in your circle, and are just eager and happy with simple handshake deals in the urge to start something fast. You throw around titles and roles casually among yourselves and don’t think much of it in the excitement of building something potentially great.

But in the process of building a strong base for your startup, you should be aware that a handshake deal is a recipe for disaster. Our jobs as founders is to always think long term, like five to ten years down the line, not just what we are going to do this particular month(s). Who would not want to have a structured safety net for themselves, which can make you as a founder feel secured, articulated, and having a clear runway when growing your startup? We should all be prepared for all kinds of uncertainties. Kind of like an insurance to protect your startup and your best interests.

Have you thought about what would happen if one of your founders wants to quit midway? What happens to their Equity? Or you onboard another potential cofounder or investor down the line, then who carries what role, weight and responsibilities? And who makes the final decision eventually for the company during every crossroad? These are all questions a smart founder ponders over right at the initial stage, even if one is not facing any of these issues initially.

It is actually very important for every startups' founders to have an agreement among themselves even before creating or registering an entity. It does makes everyone’s life easier if these agreements are done at early stages rather than trying to incorporate them at a very late stage, when it will be too late to act and react.

Paul Graham, YC’s Cofounder says that conflicts usually arise from poorly-constructed founders’ agreements which eventually can even kill startups.

And most importantly, do not go and just make an agreement for the sake of it, but make the right agreement which can take into consideration majority of conflict resolution methods of the startup world.

What is a Founders’ Agreement?

A good agreement is less about mistrust and more about protecting the startup and the partnership of founders long term.

Technically speaking, a Founders' Agreement is a legal binding contract among the co-founders of a startup, which should clearly define their collective roles, responsibilities, equity ownership, and decision-making processes to prevent future conflicts and provide a framework for operation. This Agreement lays out the rights, responsibilities, liabilities, and obligations of each founder.

A founders' agreement, like all legal binding contracts, is there to not just help us navigate our day-to-day operations, but also become a layer of protection and guidance when shit hits the fan.

Defining Founders’ Agreement Draft

What all should be covered in the agreement you are preparing? Anything and everything which can help mitigate the risks of lawsuits and defines the exact role, ownership and dispute resolution methods.

Here’s a wide-ranging list of provisions that should be usually covered in a Founders’ Agreement:

• Equity Split: How ownership is divided among founders.
• Roles & Responsibilities: Who is handling what areas (tech, marketing, finance, ops, etc.).
• Decision-Making: How key business decisions are made (majority, unanimous, or board approval).
• Vesting Schedule: Equity tied to continued involvement, with cliffs and timelines.
• Intellectual Property (IP) Ownership: Ensuring all IP created belongs to the company.
• Compensation & Salaries: Whether founders draw salaries early on, and how that evolves.
• Capital Contributions: Initial cash, assets, or resources each founder contributes.
• Future Fundraising: Approach to raising money and how dilution will be handled.
• Exit & Buyout Clauses: What happens if a founder leaves, dies, or wants to sell shares.
• Non-Compete & Confidentiality: Restrictions on competing or disclosing sensitive company info.
• Dispute Resolution: How disagreements between founders will be handled (mediation, arbitration, etc.).
• Board Structure: Who sits on the board and how it may change as the company grows.
• Time Commitment: Expected level of involvement from each founder.
• Milestones & Goals: Agreed short-term and long-term targets.
• Dissolution Terms: What happens if the company shuts down.
• Amendments: How the agreement itself can be changed in the future as necessary.

Think of these provisions as rules of a game, even before you start playing. They help us in mitigating unnecessary headaches in the future, and resolving conflicts when arises.

Mistakes to avoid when forming Founders’ Agreement

We have talked about what to include in the agreement. We should also be careful as to what should be avoided in the draft of the founders’ agreement.

The first and foremost mistake to avoid is not having the Founders' Agreement itself. "We are friends, we trust each other, it should be okay!" When things start to go downhill and you eventually realize that it is too late to fix it, not only will the startup be affected, even personal relationship you have with your cofounder gets into jeopardy.

Do not vaguely divide the equity depending on who came up with the idea, or who joined in when. You should factor in the roles, responsibilities, skills, effort, time and money everyone put in, and then work on the equity distribution. We can help you out with this, as we’re building an equity calculator which can help you in distributing equity based on each founders’ weightage towards the startup. We will update this article and include the link of the tool as and when it is ready.

Many times founders’ have no vesting schedules, and divide all of the equity upfront, which can be disastrous in many cases. Imagine you give a co-founder 50% equity initially, and they quit and leave after a few months. Years later due to your hard work alone or without any contribution of this ex co-founder, the startup reaches a very great valuation. Someone who mostly did nothing but just was lucky enough to be there during the initial period will still walk away with half of the chunk of your startup, which is completely wrong and undeserving. Always tie the equity vesting to time and contributions. The more time they’re committing and the more contributions they make towards the growth of the startup, the more they’re rewarded with the initially agreed equity share. We will go deeper into the vesting calculations in another article, as it is a big topic. You should also plan for what happens if a founder quits, underperforms, or wants to cash out.

Having unclear roles and responsibilities is also a disaster while founders' run around like a headless chicken, with no clear utilization of available skills, resources or time of each individual founder. You need to avoid overlapping tasks or having someone not fit for the specific role doing the said specified tasks, which slows down the momentum of growth. Have clear roles, which can define ownership and measure the targeted goals set for a specified period of time.

Not defining that the Startup owns the IP and not individuals, because everyone thinks they’re the creator of the product so they have an individual right over it. You should clearly state in the agreement that all intellectual property (code, designs, trademarks, or patents, etc.) created in this startup belongs to the company itself, and one or any specific pair of founders among the group cannot claim it as their own individually.

Finally, what most founders’ do is search online for a boilerplate founders’ agreement template online, and slap their branding on it and be done with it. You need to understand that every startup, every product and every country’s governing laws are unique and different, and you need to specifically tailor your agreement based on these particular requirements. Spend some time and resources on preparing these documents, as this can make or break your startup.

Draft Finalization

Once the draft is ready, go through it once, if possible with a lawyer and fill out any points which have been missed, and try to include the initial resources and long-term goals of your startup. Try to write a few lines about what your startup does, or plans to do. Mention the initial contributions of each founder, whether it is cash, property, services rendered, a promissory note, or a combination of the above. Also write down how to plan the expenses and budget, taxes handling, current and future salary compensation, and any other necessary details.

Once done, get the draft reviewed by a neutral third party, and get it signed by all relevant co-founders. All the founders should have access to a copy of this founders’ agreement either physically or electronically. This will be a legally bound agreement which can bring peace of mind to all founders, which can now let you all focus more on building and growing your startup.

This is the third of the many resources among the Startup 101 series. You can check out more articles on this topic, as and when we keep writing and publishing them. Our goal is to provide an open, unbiased and helpful resource, which can help you build your startup, and avoid common pitfalls.