What is a Founder’s Agreement and 10 reasons why your business needs one

Founder's agreement Image Credit Pixabay/rats-Apotheke
Romulus and Remus didn’t have a founder’s agreement and look what happened…

If you’ve decided to run your business through a company vehicle, then you have a safety net cast against your personal assets should the worse happen. If there is more than one founder it is essential that you agree, formally, how you are going to operate the business. You should do this at the onset, to avoid any disputes or misunderstandings, which at a later stage could jeopardize the business. As such your founder’s agreement will be in the form of a Shareholders Agreement.

Shareholders’ agreements are between company founders, which will later include new incoming shareholders. It is essential for any company that has more than one shareholder. It is particularly beneficial where shareholders are to be treated differently. Such as where there are different classes of shares or where the company is owner-managed or family-run. Also if any of your shareholders are only employees being granted shares in lieu of coding, software or other services.

  1. It can impact how the company is run

How a company is run is usually left to the Board of Directors. Often founders are directors also, but what if you wish to recruit directors who are not shareholders or you want to step away from the daily management at a later stage. It is advisable that the shareholders ensure certain issues should require shareholder approval, such as loan agreements, bringing in investment or selling assets.

  1. Shareholders may not agree

Disagreements occur in all businesses and it is sensible to agree the provisions that should apply on how a business or commercial decision is to be made and who has the authority to agree this. It is much harder to do this once the disagreement has already occurred. Provisions should include what decisions need a majority or in turn a unanimous agreement and what can be determined by the board of directors only. Laying out the areas of responsibility and how decisions can be reached avoids issues leading to disputes. Those that have only 2 shareholders 50:50 need this clearly mapped. Otherwise if you cannot agree then it could result in deadlock and the company being wound up, losing your valuable IP along the way. So decide now who has a casting vote as well as when and how it will be used.

  1. It can address how to resolve disputes

Many of the disputes which typically arise between shareholders are avoided or resolved quickly if there are documents in place which deal with the issue. If disputes do occur, there can be specific clauses that may include at what stage there would be a referral to mediation or arbitration, all of which seek to avoid court action. It can set out how shares should be valued if this is a disputed topic and it can allow you to agree to third parties who are permitted by you all to determine a dispute on your behalf

  1. It can protect the minority shareholders

A shareholders’ agreement can provide protection for minority shareholders by only allowing certain decisions to be made by the unanimous consent of all the shareholders. For example, the agreement can limit the ability for the company to issue further shares unless all the shareholders agree. In addition, if there is a sale of the shares of the company, the minority shareholders can insist on “tag along” provisions that enable a minority shareholder to tag on to a majority shareholder. This protects the minority shareholder where the majority may only attempt to sell their own shares instead of finding a buyer for all the shareholders. This is something in-coming investors will certainly welcome and will look attractive to them if they are giving you seed or scaling up funding.

  1. It can protect majority shareholders

Majority shareholders can benefit from a “Drag along” provision. This would come into play where an offer is received to buy all of the shares in a company and the majority shareholders wish to accept that offer. The rights allow the majority to force the hand of the minority shareholders on the same terms to avoid losing the deal. This is key for those that develop IP, launch and wish to sell on the product once it has been tested in the market.

  1. Attractive to Investors

Having a Shareholders’ Agreement increases the attractiveness of the company particularly for investors. It can demonstrate a professional business that has taken legal advice and planned for certain eventualities. Investors are reassured that disputes can be dealt with swiftly and that all parties have transparently laid out their obligations to the company

  1. Control the transfer of shares

A Shareholders’ Agreement can provide a provision where if one shareholder wishes to sell their shares, other shareholders or the company have a “right of first refusal” over those shares. This is a useful mechanism as it can be used to restrict who may or may not acquire shares in the company. There would be nothing worse as founders if one decided to leave and simply sold his shares to someone unacceptable with no knowledge of the business. This can also relate in the event of death, preventing beneficiaries acquiring control over your business. Instead the agreement would set out the provisions by which the Company would buy those shares from the estate instead if it so wished.

  1. Potential to link shareholdings to employment

A Shareholders’ Agreement can contain a clause whereby a shareholder’s shareholding is linked to their employment. If this is the case and the shareholder leaves, provisions can be drawn up so that they must offer their shares up for sale. This protects the Company should someone leave on bad terms. Otherwise, there is generally no requirement for them to sell their shares if they cease to be employed even if you dismissed/voted them out. How the shares are valued following a shareholder’s exit can also be addressed.

This is especially key for the technology sector as you will want to ensure all Intellectual Property created by them is correctly assigned to the Company and all data and confidential information released. You may also need to have a warranty that any IP created is genuinely unique and will not infringe a third parties rights, which would jeopardize the business. In the event that you have promised shares to someone to help you start the company, any conditions or restrictions on those shares can be dealt with in the shareholders agreement,

  1. Restrictions

Circumstances can arise that lead to founders having to leave the business. The company can protect itself by adding restrictions on shareholders if that happens. These may include: on a shareholders’ ability to set up in a competing business or poaching clients or using your IP such as unique code or software. These restrictions can be more restrictive than those contained in an employment contract and can protect the interests of the company. Likewise if this is not your only business other interests could be disclosed here to prevent anyone taking action against a shareholder for conflicting interests at a later date if a dispute arises.

  1. Can vary how much dividends are paid

A Shareholders’ Agreement can set out the various dividends paid to each shareholder where there are different cases of shares to cap or limit withdrawals to protect the capital and cash flow of the company.

By not having an agreement in place, shareholders may end up walking away with too much, or the company business can grind to an abrupt halt under the management of a minority shareholder veto. This means it’s important to consider options carefully and, if you decide you need one, get the right shareholders’ agreement for your circumstances. Templates do not work, you need to design this around your needs and all agree to the provisions so you have a sound platform on which to build your business.

These are just a some of the reasons why a Founder’s Agreement is important and useful for a company to protect individual shareholders.


A City Law Firm Logo (Image credit : A City Law firmManaging Director & Founder of A City Law Firm who practises in both commercial law and litigation, having been admitted to the roll in 2005. If you require further advice or assistance, please do not hesitate to contact karen@acitylawfirm.com

A City Law Firm Limited is a leading entrepreneurial law firm in the city of London, with a dynamic and diverse team of lawyers. It was awarded most innovative law firm, London 2016 and Business Law firm 2017. They specialise in start-up business law, the tech industry, IP and investment

 

 

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  1. This was very easy to read but informative . I didn’t think to get one when I started up and now I’ve fallen out with one of the founders it’s a nightmare . So good advice

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