Starting up a company with co-founders can be a rewarding and exciting adventure. However, it is not unusual for personal differences and issues to crop up between co-founders that you may not have considered when starting out. Thankfully, you can prevent small or insignificant issues from becoming catastrophic problems if you are organised and upfront with your co-founders from the beginning. Start by making sure you have the right agreements in place before you kick off operations with your startup.
1. Put it in Writing
Importantly, you should first think about preparing a document that acts as a legal contract between all co-founders. If you are setting up a company, you will need to enter into a shareholders agreement with your co-founders. A shareholders agreement defines the relationship between the shareholders of the company as well as the following:
- How shareholders will manage business arrangements;
- Shareholders’ and Directors’ rights;
- Responsibilities and obligations;
- How decisions are made;
- How shares will be issued or sold; and
- How a shareholder can exit the business.
Having these agreements in place at the start will assist in giving each co-founder clarity, a sense of security and also ensure that all parties address both present and potential issues that could arise in the course of doing business together.
Ownership Interests and How These May Be Transferred
One of the main things you will cover in your shareholders agreement is the ownership interests of each co-founder in the new company. If there are two co-founders at the beginning, they may structure their ownership of the company as 50% each. Alternatively, the relationship may be such that one party is the primary founder and the second party was brought in to help with some specific aspect of the startup. In this case, they may structure the ownership such that the second party will be given shares that vest over time.
Providing a key employee or co-founder with vesting shares will incentivise them to stay in the company and help you build the startup over a longer period. Vesting is where a co-founder may be issued with five shares, but receive only the first share after working in the business for one year, the second after working with the company for another year, and so on until they receive all five shares after five years. Vesting structures can be set up in different ways to award a percentage of shares at monthly or six monthly intervals after the first year (known as a one-year cliff), depending on what will work best for your company and growth plans.
Despite having a rewarding vesting structure in place, sometimes employees or co-founders want to part ways or sell their share in the company. Deciding who will step in and purchase the departing founder’s ownership interest will be a tough task for the remaining founders if it has not already been discussed.
- The shareholders agreement should be tailored to reflect the following:
- How the original co-founders intend to hold or transfer shares; and
- What actions can affect their ownership of the company during their time and also when they choose to leave, transfer or sell shares.
You should consider including a “right of first refusal” clause and “tag along” and “drag along” clauses in your agreements. These clauses will cover different circumstances in which a co-founder chooses to sell or transfer their ownership shares in the company.
What If A Co-Founder Is Not Pulling Their Weight?
You may also wish to distinguish between a “good leaver event” and a “bad leaver event” in your shareholders agreement. This clause can help determine the purchase price of the share sale, triggered by the co-founder leaving and the circumstances surrounding their departure. An example of a bad leaver event may be when a co-founder does not perform their agreed upon duties to an acceptable standard. Your agreement should clearly specify;
- What the exact roles and responsibilities are for each co-founder;
- How performance is measured and reviewed; and
- The process for other co-founders to vote to remove the non-performing colleague reasonably.
It is also important to ensure your agreement covers how co-founders may invest in the business and what you will all receive as a salary.
2. Protect Your Ideas
A well-drafted restraint or non-compete clause in your shareholders agreement will prevent co-founders who want to leave the company from being able to open up another competitive business or solicit any of your clients or employees away from you. This will apply for a period in a particular area, for example, 12 months in New South Wales. Such a clause will require an exiting co-founder to return all intellectual property and not to use any intellectual property belonging to your company once they have left the business. Protecting your ideas and client base in this way will be essential to growing your startup.
3 Decide How to Decide
Your shareholders agreement must also cover voting rights. Often the process of making business decisions is tied to the amount of shares (including voting and non-voting shares) each person has in your business. Usually, one share equals one vote. If you own 75 out of 100 shares in the company, you have 75 votes. However, you may wish to have a board of directors vote on significant company decisions – depending on what issues you anticipate arising.
4. Resolving Disagreements
Sometimes co-founders are going to disagree on how to operate the business or come to a certain decision. Figuring out what you are going to do in these situations to move forward is important to ensure your startup gets underway. A clearly set out dispute resolution clause will include the process to follow when there is a deadlock, such as passing a special resolution or attending mediation.
If co-founders still can’t reach an amicable discussion, this clause will set out the process for purchasing the shares of the other shareholder involved in the dispute. Although an uncomfortable topic to discuss when first starting your business, ensuring your agreement addresses how you will resolve any disputes will save you time and stress in the long term.
5. Figure Out Your Intentions Early
An important part of starting a business is setting goals of where you want to see it heading in the short-term, as well as the long-term. Although this may change over time, it is useful to have a sense of what each co-founder wants from the company. Also, what are the expectations that fellow co-founders have for one another and is this different from the expectations you have for yourself? What parts of the business are you able to compromise on and what are you determined to uphold? All of these questions are worth considering and talking over carefully with your fellow co-founders, as well as a lawyer. It’s advisable that all co-founders seek independent legal advice so that they come to the negotiation table on a level playing field.
When working toward establishing a startup or new business, you are inevitably going to experience a raft of challenges. Ensure that you comply with legal requirements and carefully consider any potential problems so that you can avoid becoming overwhelmed down the track. Importantly, if you have any questions – ask! You can get in touch with our startup lawyers on 1300 544 755 or filling out the form on this page.