Do you know what a co-founders agreement is?
Anyone starting a new startup should enter into a cofounders agreement with the co-founders they gather. This agreement outlines their understanding with respect to the new venture and protects the rights of all the cofounders.
This work is easy to find, and many new entrepreneurs are unable to hire a lawyer at this stage due to lack of funds. But for you, it’s a great opportunity to cultivate future clients, build trust and credibility, develop a track record etc.
When you do it for foreign startups, you can even get paid decently well.
So let’s first learn how to draft a co-founders agreement.
Let’s imagine a situation.
Captain Marvel and Wanda Maximoff are about to graduate from Stanford University.
They have a startup idea to create a self-defence technology to defend against any nuclear attack, and meet all the energy needs that the world will need. They call this “Project Infinite Energy”.
They decide to start working on their plan, and need a co-founders agreement. Which clauses should be there?
1 – Nature of business
Cofounders often fight over the direction of a business after some time. This can be a disaster.
You need to write down the scope of business. Keep it broad so that new activities can be absorbed. But at the same time, it should not be so broad that there is no meeting of mind between parties about the direction of the company.
The Co-Founders are commencing a business venture to explore and develop self-defense technologies against nuclear attacks and for harnessing high amounts of clean energy (Business). The Co-Founders may alter the scope of the Business, add or reduce activities by mutual agreement.
Optional: The Co-Founders agree that the Business will not work on offensive technology.
It is a great idea to include a not-to-do list where possible.
That will reduce future conflicts.
When you are drafting a contract, you want to think of what can go wrong in the future and draft clauses to avoid such things going wrong or writing down consequences of bad behaviour by parties.
This is what makes a contract watertight.
It will make those founders appreciate your wisdom and skill as a lawyer. Your job is to look out for your clients, not merely typing out clauses.
2 – What is the co-founders’ share going to be?
With 2 founders sharing equal shares, it is going to be relatively easy to draft. Let us assume that you have a third owner, Mr. Tony Stark as well, who wants 20% share, and who agrees to advise the Co-Founders and fund the company upto USD 200,000.
Now, draft a clause where Marvel and Wanda have 40% share each, and Tony Stark has 20%.
Ownership of Co-Founders:
The Co-Founders’ ownership interest shall be as follows:
- Marvel: 40%
- Wanda: 40%
In addition, Tony Stark shall have 20% stake in consideration for funding the Business for up to USD 200,000 over the next 4 years and giving advice to the Co-Founders when needed.
Tony Stark shall have the status of a Co-Founder in the Business.
3 – For how long have the co-founders committed to work together? What is the nature of their work commitment?
Now, let’s say that this period is 4 years. Very good.
- Will they work full-time or part-time?
- Can they perform other side gigs? How many hours a week or month can they do this?
- If they are working exclusively for the startup, will they be allowed to volunteer at charities or write books, for example?
Also, write a clarification that their side gigs should not be competing with the current venture. It is in their common interest not to perform ANY work for competitors, or start a competing company.
Commitment of Co-Founders
The Co-Founders shall be expected to be involved full-time in the execution of their responsibilities towards the Business.
The Co-Founders will not carry out any competing activity that conflicts with their duties.
Until the Business generates sufficient revenues to pay the Co-Founders a salary, they may work part-time for up to 40 hours in a month, provided that they do not undertake competing activities, or work with competitors of the Business.
Optional: The Co-Founders shall exercise their power to give consent in good faith and not withhold consent unreasonably.
4 – What happens if one of the co-founders leaves earlier than 4 years?
Say, one of them, say Wanda, gets a job from Google in 2 years after their degree is completed.
What happens? You need a fair rule here. One person’s leaving should not impact the venture if the other person is willing to work.
Why should one person do all the work if the person who has left will also benefit?
That is where you need a ‘vesting clause’ – this clause ensures that the ownership is proportionately granted for every year you work.
Vesting of Co-Founders’ Interest
The stake of each Co-Founder in the business shall vest pro-rata on an annual basis, until the minimum commitment period of 4 years is completed, as follows:
| Time | Percentage of ownership |
| 1 year | 25% |
| 2 years | 50% |
| 3 years | 75% |
| 4 years | 100% |
If a Co-Founder leaves, or is fired or dies before expiry of the minimum commitment period, he/ she shall only retain the amount of ownership interest that has vested until then.
5 – Who owns the IP in the work done by the Co-Founders?
You don’t want a co-founder to use one of their projects/ codes/ ideas which they worked on in the company, for a future job. This is where you need an IP assignment clause.
Each Co-Founder hereby irrevocably assigns to the Business all the intellectual property in all the work done for the Business without need for any further action to be taken by the Business.
The Co-Founder agrees that he or she cannot use any such work or the intellectual property in it for her personal uses or in any other employment.
Where a statutory filing is required to this effect under the applicable law, the Co-Founder shall assist with such filing.
6 – How will they make decisions? How frequently should they meet? Which are the matters on which they cannot proceed without taking the other co-founder’s alignment?
- Keep a flexible meeting system, where they meet at least once a quarter or in six months to record decisions. Virtual meetings should be possible
- Give the option to meet more frequently if they need to – any one of them should be able to call a meeting, at short notice in a startup
- Have a list of matters on which all co-founders’ consent is needed – e.g. admitting a new co-founder, raising investment, obtaining a loan, changing the nature of business, etc.
Meetings and Decision-Making:
The Co-Founders shall be free to meet as frequently as possible, and conduct meetings at least once in 3 months. Key decisions taken by the Co-Founders shall be recorded in writing. Decisions on the following matters shall require unanimous consent of both Co-Founders:
- Appointing an adviser to the business
- Admitting a new co-founder
- Raising investment
- Giving equity to an early employee
- Starting a new product or service line
- Obtaining a loan
- Collaborations with other parties
7 – How will disputes be resolved?
You can include a simple dispute resolution clause here.
Dispute resolution: All disputes arising from, out of or in connection with this agreement, including its validity, shall be submitted to final and binding arbitration, by a sole arbitrator, in accordance with the rules of the American Arbitration Association and the laws of the State of California.
This is what a co-founders agreement looks like. Let me take you through it.
Here are some additional clauses that are there in a co-founders agreement:
- Admission of new co-founders
- Restraint on competing business (or a non-compete clause)
- Performance goals and consequences of non-performance
We will send you a cofounder’s agreement template in the giveaways.
Alright, let’s try to draft a clause on admission of new co-founders.
What will the rule for admission of co-founders be?
Let us assume that it will be unanimous.
How will the equity of the other co-founders adjust? Will it be proportionate or will one co-founder have to reduce their share individually?
Let us assume that it will be proportionate.
Now, draft this clause and share it with me in chat. I will give you some feedback and then share a model clause.
Here is a model clause:
A new Co-Founder can only be admitted with unanimous consent of all existing Co-Founders. Upon admission of a new Co-Founder, the shares of all the existing Co-Founders will dilute proportionately.
Now, let’s draft a clause on the salaries of co-founders. We want to state that the Co-Founders can mutually decide how much salary to draw, but it must be within certain parameters to prevent disputes later.
Maybe one co-founder wants to draw more salary to meet expenses, while the other wants to re-invest the profits in the business.
So let’s try a parameter – they can draw upto 5% of the company’s revenues by salary. A ceiling amount can also be written, e.g. INR 1.5 lakh per month, until the company crosses 10 crores of revenue.
Would you like to draft this?
Here’s one way to draft such a clause:
The Co-Founders can mutually agree on the salary due to them, upto 5% of the company’s revenues, subject to a maximum of INR 1.5 lakhs per month. This limit may be increased mutually once the company exceeds INR 10 crores of annual revenue.
Of course, this is not all and there is more to learn on this subject, but we have limited time here.
This is the first agreement that you can help out a young entrepreneur with. Do this well, and this can mark the start of an early professional relationship.
You can use these principles to draft other agreements like partnership or LLP agreements, shareholders agreements, and articles of association across the world.