Founders Agreements

I was reading a question on Answers OnStartup from someone who was not happy with his founders agreement, and wanted to know his options for renegotiating. The agreement made was as follows:

I early on pushed for getting an operating contract agreed to by all three because I intuitively believed “make things explicit” would prevent heart-ache in the long run. My one big mistake was not doing due diligence, that I’ve now done, on how things should be done for a startup. The agreement that we are currently under is each founder gets a third, but we log our hours and get paid an hourly wage (significantly less than my contract rate but significantly more than A’s salary rate) which will be paid when when the company starts making money. The wage was a concession to me because I knew I’d have a lot of up front labor (but its now not seeming worth the risk its supposed to offset).

Partnership Agreements

The meeting of partners

The issue with this arrangement is simple – there’s no vesting, and the contributions being made by each of the three founders is not going to be equal in terms of time (although the value of the contributions may be equal in other ways).

First, what’s vesting?

Vesting in terms of a startup is the granting of partial ownership in the company (that is, shares in the company) that the employee gets over time. What this does is ensure that the employee will do their work (or they will be forced to sell the unearned component of their shares), while guaranteeing to the employee that they will, in fact, get their shares if they do the work required.

This is important in a startup in which the various people involved will have different levels of contribution, at least in the early stages. However, an assumption is made that the idea, IP, or company is initially owned by a single person (or company) which is recruiting others. In order for the initial founder to guarantee his investment in other people, he can vest their portion of the company.

In the case of the question above, however, the company was founded with three people, each with an equal share. Vesting was not actually an option, since no one owned the company beforehand (that is, who is the current owner of the company if not all three founders). Therefor, what this person needs is not a vesting schedule, but a solid founders agreement.

A founders agreement can be as simple as a single sheet of paper called a Statement of Understanding. The first lines of the paper would be something along the lines of:

This document is informal, and is intended to be the basis for a formal Memorandum of Understanding between the parties named below. It is meant to be interpreted as plain English as understood by a reasonable person. It is not a contract, but is intended to define the parameters under which a company may be formed.

The rest of the document outlines who the various people or companies are subject to this statement, what each one will be contributing to the partnership, and what each will get in return. Over time, this document can be expanded to include things like payout options, buyout options, dividends, reinvesting profits, and so on.

Regardless, it is critically important that any partnership have such a statement at a minimum, in order to prevent misunderstanding later. It should be easy to understand – it’s not about creating a complicated legal document that covers all contingencies. It’s to make sure that each of the partners understands what is expected of them and what they will stand to gain from the arrangement.

If you are looking to get into a partnership with someone, whether you are initiating the arrangement, or the other person is, make sure that you have such an agreement, and that any concerns you might have are outlined in it.