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How To Build a Startup Founder Equity Agreement

Nida Bohunr | November 10 2021

You are an aspiring entrepreneur who has just had their bright, once-in-a-lifetime, million-dollar idea. As you explore the prospects of your business venture further, you have also run into a few potential co-founders. Sharing a common appreciation for your idea and the willingness to take advantage of this opportunity, you and your co-founders are ready to launch your startup.

As you go about building your founding team, you might hesitate to formalize your relationship with your partners. After all, everything seems to be going well, there must be no need to make things unnecessarily complicated by writing everything on paper, right? Well, not quite. Although it is true you and your co-founders are in this business venture together, forming a startup founders agreement is imperative to the health and continuity of your new business.

A startup equity agreement is complex, and writing one up for your startup venture can prove to be a challenging task and one you might even consider unnecessary.

In a study conducted by HBR with 3,700 startup founders working in more than 1,300 startups in the USA and Canada, a strong link was uncovered between an increase in turnover and growing discontent over equity. As a result, co-founders often have to deal with conflicts, uncertainties, and even resentment – leading to a leadership gap and eventual breakdown of the partnership.

To prevent that and put the necessary safeguards in place, a founders’ agreement is required. Do not skip this essential step in favor of your startup dreams and aspirations.

 

Find out all about startup equity agreements here in this article, and equip yourself to avoid conflict and costly mistakes!

What is a founders equity agreement?

A startup founders equity agreement is a contract between the founders of the startup that governs their business, unique roles and responsibilities, and relationships with one another. The agreement lays the foundation for any individual or overlapping, rights, responsibilities, liabilities, and obligations of each startup founder.

It is important to note that a startup equity agreement typically deals with matters that are not directly or adequately discussed in the company’s operating agreement. In particular, these are designed to protect the interests of each founder, acknowledge that all founders are in consensus about the company’s basic organizational structure, and dictate how the founders will work together for the welfare of the business itself.

 

Importance of a founders agreement for a startup

A startup founder agreement does a lot more than just formalizing the relationship between you and your co-founders. There are certainly many reasons that Forbes names the absence of a founders agreement in their list of top 10 mistakes made by new startups.

 

Here are some compelling reasons you should not disregard writing an equity agreement for your startup, despite it being discretionary in nature and law:

Guiding Principles – A startup founders’ agreement lays down the guiding philosophy and principles for all founders to follow. Central to the entire business venture, these principles, when included in the agreement, legally bind the partners to respect these values and philosophies; this is particularly important in times of conflict and heated disagreements between the partners themselves.

Legal Action – Formalizing all parts of a business in the equity agreement, including which partner owns what percentage of the overall business or its various branches, is an important deterrent to undue and disproportionate legal action against any of the partners. Forging an agreement helps mitigate the risk of a lawsuit over who owns the business.

Conflict Prediction and Resolution – Most of the provisions of an equity agreement for your startup will attempt to reduce the likelihood of conflicts between the founders by considering and answering various questions you and your partners might be faced with in the future. Such questions can include what happens if one of the partners resigns, or if any partners can launch any other business ventures while being a founder in the startup in question. By answering these questions well ahead of time, the agreement saves you a lot of time, trouble, and often, valuable business resources!

Although these are only some of the many business and strategic advantages of forming a startup founders equity agreement, most other important benefits are weaved into the provisions of the agreement itself. Let’s now move on and discuss exactly what makes up the primary contents of the equity agreement.

 

Provisions of the equity agreement

There is a myriad of provisions that could be addressed in an equity agreement for startups. Every section of the agreement pertains to one particular aspect of your partnership with your co-founders, the functioning and management of the business venture itself, and the ownership structure. Find out what you need to include in your startup’s founders equity agreement in the next section.

 

1. Founder details and ownership structure

The first part of this section is as easy as it gets. Just list down the names of all co-founders and partners on paper along with the name of the startup you and your partners seek to launch and then manage.

Next, collectively decide about the ownership structure of your company. Depending on the type of business you hope to operate, you will need to divide the ownership of the business and explicitly talk about who owns what part of the business, and which owners hold what percentage of management interest (only applicable if your company has owners in an economic sense or otherwise in management too).

If you are still confused about the type of business to select for your startup, talk to one of our experts at Monily today to determine the kind of business structure best suited for your company!

 

2. Initial, expected, and future contributions

Every founder of your company can have a distinct impact on the structure, business, and ideas involved in the launch of your startup.

They can do this by contributing cash and funding, or property, services, and business ideas. In this section, your job is to approximate the monetary value of all the contributions of the concerned partners and list them down in the agreement.

It is also important that you do not forget to include what future services, resources, labor, time, or other tangible or intangible materials the partners are expected to, or have already promised, to contribute.

 

3. Taxes

All matters concerning taxation are complex. It is in your best interests to consider hiring a tax specialist to assist you in writing down all the complicated taxation clauses in this section. If you are still confused, reach out to us at Monily and find out all about the options you have that can help you – such as tax incentives that will help you save money, reduce conflict, and allow your business to grow!

 

4. Equity and vesting

This section of your startup equity agreement will be crucial to the health of your business as it grows. Equity, vesting, stocks, shares, and the compensation of all of these, however, is a very complex process, particularly for new startup owners. Vesting your equity in the venture translates to a process by which you acquire ownership rights in the business.

As far as a founder’s equity in the startup is concerned, each partner receives a stock of shares that represents his or her stake in the business. Equity vesting is important for your startup equity agreement as it not only spells out the shareholding portion of the partners but also what happens if a founder quits the business before a vesting schedule is completed.

 

5. Resignation of a partner

There are many instances in which you might find one of your co-founders leaving the organization. It is usually in the form of a resignation or removal by other founders, but it can also be because of factors out of your control, such as a partner moving away, or even dying.

This section of the startup equity agreement will establish the rules about who can buy the shares of the former partner and how. It is prudent to set the price for the share as dynamic instead of static; this means that the buyout price will be directly related to the market value at the time of the buyout.

 

6. Rights and responsibilities

This section of the agreement is crucial to the managerial and operating health of your business venture. Here, you and your partners will work to decide the roles, responsibilities, and special powers allocated to each of you, particularly those relevant to the management of and economic commitments of the partners towards the company.

You can also talk about the rights of your co-founders. Write about whether or not any partner can launch another startup venture or project while still serving as a founder at your company. The startup equity agreement will outline who can approve what actions within the organizational structure, and which partners can vote on matters concerning business activities, or whose vote holds what kind of weightage.

 

The bottom line

Writing up a founders equity agreement for your startup is a long, complex process that pays off in the end. It helps to have a formal agreement in place to help navigate everything from your daily operations to business planning to profit-sharing and the likes.

See Also: How To Manage And Extend Your Startup Runway

That is why we are here to help you make all the necessary decisions you need to about the startup equity agreement, understand what each section talks about, and recognize particularly important clauses that might later be crucial for the company and its foundational, organizational, and economic health. Reach out to us now and talk to one of our many experts and find answers to all your questions today!

 

Author Bio

A highly skilled accounting professional at Monily, having extensive and diverse experience of working in US healthcare and agriculture industry. Nida is a CA finalist with expertise in Bookkeeping, Auditing, Bank Liaison, Tax Preparation, Accounts Payable, Accounts Receivable.