Many founders have started a business together based on a great idea, often thinking they’re equal partners who share the same vision.
But what happens down the line when one person feels he or she is pulling more weight or bringing in more capital or decides to leave the business and take its intellectual property?
In cases like these a founders’ agreement can be critical in preserving the founders’ interests and avoiding a messy breakup.
- Now, not later. “Usually people don’t worry about it until later on, but later on is too late,” says Paul Schwartz, CEO of Stony Brook-based ThermoLift Inc., which is developing a natural-gas air conditioner and heat pump. “It’s the difficult discussion to have amongst the co-founders.”
He’s used founders’ agreements and walked away from deals where another party declined to sign one. “In my experience, if you can’t get that agreement in the beginning, it’s not a transaction I personally would ever want to be involved with,” says Schwartz, noting it’s important because “it sets a benchmark of expectations.”
- Key elements. In general, an agreement lays out founders’ roles, responsibilities, equity interests and ownership of intellectual property, says Marty Zwilling, CEO of Phoenix-based Start up Professionals Inc.
One of the hardest elements to decide upon is equity interest in a startup.
At the very least, he says, you should address five key elements that will help determine equity allocation: the level of responsibility and time each founder will put in; how much money each party will put it; any intellectual property or trade secret or patents a founder is bringing to the table; any specific connections or relationships a party has that are beneficial to the business; and any prior experience running or starting another business.
- 50-50? If parties go in thinking they’re equal, that usually ends in a battle, Zwilling says. “Ultimately someone isn’t happy with someone’s contribution.”
You must recognize each founder usually brings unique skills and value to a company, says Alon Kapen, a partner in emerging companies and venture capital at the Farrell Fritz law firm in Uniondale.
- Stock issues. Founders should approach initial stock ownership knowing this could change later when outside investors are brought in, he says. In general, restrictions on shares should reflect the nature of each founder’s contribution.
There are several questions to consider, he says: Is the stock fully vested? Should a founder who leaves the company participate in any post-departure profitability? Should there be restrictions on stock transfers, such as a right of first refusal requiring a founder who wants to sell shares to offer them first to other stockholders or the company?
- Ideas. Be sure all the intellectual property associated with the product or technology, developed pre- or post-incorporation, is owned by the company rather than an individual, Kapen says.
While it’s hard to cover everything, he says he tries to get founders to focus on issues that will be relevant before their first major outside funding. That’s because an outside investor will likely change the terms of any agreement.
Andrew Hazen, who has co-founded half a dozen companies in the past decade, including Angel Dough Ventures, a Westbury-based seed fund, says he’s operated without founders’ agreements but wishes he’d used them in certain circumstances.
He said he has had co-founders with whom he did not see eye to eye once the business was launched, and there were disagreements over responsibilities and where the business was going. “Everybody’s ideas and plans and visions are bound to change over time,” says Hazen.
Top co-founder conflicts
- Disagreement over roles and responsibilities
- Misaligned expectations
- One or more founders feeling they contribute more than others
- Disputes over equity split
- Personality clashes
Source: Marty Zwilling, Startup Professionals Inc.