Working With a Founder Team Before You Incorporate? Perhaps You Should Consider a Founders’ Agreement.

Incorporation or LLC formation generally requires that the relationship among the founders be formally resolved and committed to paper — things like equity splits, operational roles, IP ownership, dispute resolution mechanism, and founder exit procedures are covered by incorporation/formation documents such as operating agreements, stock purchase agreements, and/or shareholders’ agreements. But many founder teams wait until they have a product, or at least a MVP, ready to go to market or to pitch to seed investors, before they incorporate or organize their company. Of course, the product develop process can take weeks, months, sometimes even years. In that span of time, the dynamic of the founder team can change — roles, responsibility, and input can grow and shrink, and founders can often leave the team to pursue other opportunities. Unfortunately, pre-incorporation founder teams rarely have agreements in place to handle these eventualities, leading to uncomfortable and potentially legal-issue inducing situations where different founders may have differing expectations of what they are entitled to — for example, a founder who departed prior to incorporation may think he or she is still entitled to some piece of the company based on their contribution to the product’s development. Ideally, when setting out with a founder team to develop a product or service that is intended to eventually become a startup, the team will write out a founder’s agreement. There’s no need for magical legal incantations, so it is not always necessary to have a lawyer draft one (although if the team is having trouble coming to consensus, a lawyer may be needed to mediate disputes among founders and suggest compromises and solutions), as long as the agreement clearly spells out what the team wants. However, it is important that the agreement discuss the important issues in a pre-incorporation founder team and provide the answer to resolving disputes when they come up — it’s easier to agree on how to resolve a contentious issue before it arises when the founders still like each other, rather than after the issue arises and founders may like each other a little less. Some of the more common issues addressed include: – Equity split: The team can agree at this point how to split the equity of the to-be formed company. However, they should also recognize that roles and responsibilities can shift as the team dynamic works itself out. Accordingly, the agreement should also provide for the ability to shift the equity split. For example, the team can set benchmarks and milestones leading up to the company’s formation that will “vest” equity in a particular founder. Alternatively, the team can set up mechanisms to review the equity split when the team goes to incorporate. Ideally, the team should ensure that everyone is comfortable with the split when the company is incorporated — many disputes arise when a founder feels he or she did not get his or her fair share of the company. – Roles and responsibilities: Connected to the first topic are the roles and responsibilities of the founders, which can be spelled out in an agreement. If everyone understands their responsibilities in getting the company launched, it can minimize the chances that other founders feel that someone did not pull their weight because they believed that founder had some responsibility they did not complete. – IP ownership: Usually, it is understood and should be agreed to that all IP generated in the development of the product/service will belong to the company to be formed, and that the founders will execute any necessary assignment agreements. Of course, some founders may believe that the work they did belongs to them, especially if they leave the team prior to incorporation. – Early exits: Perhaps most importantly, a founder agreement should address what happens in the event that a founder leaves the team prior to the company’s formation. Most draconian would be that a departed founder surrenders all interest in the company and any work they did on the product or service. If the agreement sets milestones for equity vesting, the departed founder could be granted equity for the work they did perform, or (if the company wants to avoid having “dead” equity in a non-participating founder) there could be cash-out mechanisms to compensate the departed founder for work performed. The early exit provisions may be the most important in a founder agreement, since it resolves a departed founder’s interest in the company, rather than leaving it as an open question, which could be an issue for the company if it takes off or could be a red flag to investors.

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