Your startup is beginning to form – you have an idea and partners and now it’s the time to make your relationship binding. It may seem trivial now when you are all in good relations, however, don’t forget that as soon as there is money on the table, disagreements will arise. That’s why it is important to draft a Founders Agreement in advance.
These are the main issues you should take into consideration while drafting a Founders Agreement:
- Share Capital Allocation – An appropriate share capital allocation should consider the expectations among the founders regarding the past and future contribution of each founder to the company. You should also consider the allocation of equity (shares or options) not only to the founders but also to other parties who were involved in the development and did not receive any compensation since that may prevent future claims of non-payment.
- Funding – Founders generally contribute to the company by the time and energy they invest in the company, however, founders may also contribute cash, and if such expectation exists among the founders, it is advisable to specify it in the agreement. If the investment in the Company made by a shareholder’s loan, the repayment terms should be specified in the agreement as well.
- Share Transfer and Issuance:
- No Sale Period – A provision which includes a period of time during which a transfer of shares by the founders is prohibited. The purpose is that for at least a certain period the founders will have an interest in the Company as shareholders.
- Right of First Refusal – The right to purchase, on a pro-rata basis (i.e., relatively to each shareholder’s holding percentage), shares offered for sale by another founder to a third party. This provision is intended to enable to keep the Company’s share capital among the existing shareholders and to enable an existing shareholder to increase its shareholding in the company in the event of such sale of shares as aforesaid.
- Right of Co-Sale – The right to participate, on a pro-rata basis, in an offered sale of shares by another founder to a third party. If the other founders elect to exercise this right, the number of shares to be sold by the offering founder shall be respectively reduced.
- Preemptive Right – The right of the shareholders to participate, on a pro-rata basis, in the issuance of new shares of the company, in order to maintain their respective shareholding in the company. You may also consider enabling shareholders who fully exercise this right to also participate with respect to the pro-rata portion of other shareholders who elected not to participate (in professional language this is referred to as “Over-Allotment”).
- Allocation of Positions – It is highly recommended to define in advance the position of each founder in the company, and the scope of time that each founder will be required to dedicate to the company. Note that investors will usually ask the founders to commit 100% of their time to the company.
- Repurchase – You may consider subjecting the shares (or a certain percentage of the shares) of each founder to a mechanism according to which if such founder’s engagement with the company, whether as an employee or consultant, is terminated during a certain period of time, the company will be entitled to repurchase such shares for only the par value of the shares (this action will increase, pro-rata, the holding percentage of the other shareholders). This mechanism will usually include a provision under which only if the founder resigns without a “Good Reason” or is terminated by the company for “Cause” (as such terms will be defined in the Founders Agreement), the shares may be repurchased. The founder’s shares will be gradually released from this restriction at the end of each period of time set forth in the agreement, usually at the end of each month or quarter of the founder’s engagement with the company.
- Appointment of Directors and Decision Making – The scope of authority of the founders to appoint directors should be agreed upon in the Founders Agreement. Furthermore, it is preferable that critical issues in the company’s life (e.g., a material change in the company’s business, a merger or acquisition of the company, or a liquidation of the company) will require unanimous consent or at least a special majority.
- Assignment of Intellectual Property – In addition to the standard provisions in this context relating to the assignment of IP developed by the founders to the company, you should examine whether there is a need for the assignment of specific IP such as patents – transfers of this kind may have tax implications and you should seek appropriate legal advice.
- Confidentiality and Non-Compete – These are standard provisions in a Founders Agreement, however, it is important to note that Israeli courts tend to limit non-compete obligations. Furthermore, you should note the difference between a founder’s commitment to non-compete as a shareholder, as opposed to its non-compete commitment as an employee. In the first case, courts tend to approve the non-compete obligation, while in the second case courts tend to limit the term and scope of such obligation.
Right here at the JumpStart website you can find a variety of customizable agreements for download, including a Founders Agreement.