Co-found a startup? Make sure your partnership agreement covers these 12 key points

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By Richard D. Harroch

When starting a new business with partners or co-founders, there are a number of key issues to address in a formal partnership agreement or co-founder agreement. Discussing and resolving these issues early on can prevent problems and conflicts later, and it can help ensure that all parties are in agreement on how the business will be operated.

As a preliminary, the business should not be set up as a general partnership, as this may result in the liability of the partners for the debts and obligations of the business. It usually makes more sense to start a new business as a corporation or a limited liability company (LLC). (See LLC vs Corporation: Choosing the best structure for your startup.) My personal preference is to avoid an LLC and start the business as a corporation.

Here is a list of key issues to address in your agreement:

1. Capital contribution. How much money or property will be put up by each founder when starting the business? Will a founder provide services instead? Will the contribution be a capital contribution or a loan to the business? What if the business needs more money to operate? Is each founder obliged to contribute up to a certain amount?

2. Percentage ownership of the business. What percentage of the company will each founder initially own? The percentage of ownership doesn’t have to be equal, and a founder who comes up with the business idea or most of the capital will often expect to get 50% or more. The percentage of ownership can change over time as new capital is poured into the business, either by the founders or by outside investors. What percentage of founders’ ownership approval will be required to allow new capital contributions by founders or new investors? Should the founders’ shares be acquired based on the company’s continued ownership over a period of time? Without an acquisition, a founder could leave right away and still own all of their shares, which may be acceptable if it comes to the business agreement between the founders, especially if a founder paid cash for their shares.

Parties should also consider reserving 10-20% of the shares to be awarded to future employees, especially in the case of technology companies trying to attract and incentivize employees.

3. Intellectual Property. You will want to ensure that if a founder brings intellectual property to the business (such as inventions, patents, business plan, business concept, code, etc.), that it is properly transferred to the company and held solely by the company. And as a precaution, all founders, employees, and independent contractors must sign a confidentiality and investment assignment agreement for the benefit of the company. (See Top Issues Related to Confidentiality and Invention Assignment Agreements with Employees.) This will ensure that any intellectual property developed by Company employees and contractors working for the Company will in fact belong to the Company. Future venture capitalists will pay particular attention to this.

4. Titles and Roles. What are the titles and roles of the founders? Typical executive titles are Chief Executive Officer, Chief Financial Officer, Chief Technology Officer, Chief Marketing Officer, and Chief Strategy Officer. Is each founder’s role part-time or full-time? Specificity is important here. You don’t want one partner to expect to work 10 hours a week and the other partners to think they will work 50 hours a week. And who will be on the company’s board of directors? And how can roles change over time? Should founders have employment contracts setting out the terms of their employment and how they can be terminated, with specified severance payments?

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5. Remuneration of the Founders. What salary and benefits will each founder be entitled to for their role in the company? Will it be payable now or deferred until the business is past the early stages, in order to preserve capital?

6. Decision making for key issues. How will key decisions be made and with what approval from founders/shareholders? How will day-to-day decisions be made (the CEO is usually authorized to make day-to-day business decisions). Important issues may require 51% or 75% approval in the interest of the founders or shareholders. Significant issues could include bringing in new capital/investors, selling the business, changing the articles of association or incorporation documents, large debt, changing the number of directors, etc.

7. Withdrawal from the Company. What happens if a founder no longer wishes to be active in the company and wishes to pursue other activities or retire? Will the company have the right to buy back its shares, and at what price? Will there be any restrictions on competing with the company after the withdrawal (this gets tricky as some states don’t allow non-competition clauses)? What happens if a founder dies? (The estate would generally inherit his shares).

8. Distributions or Dividends. If the company becomes profitable, how should the distributions or dividends be determined? This is usually left to the company’s board of directors. It may make more sense to keep profits and reinvest them in the business rather than issuing dividends.

9. Share Transfers. What restrictions will there be on the transfer of shares from a founder to a third party? Will the other founders have a right of first refusal on the transfer of these shares?

10. Dissolution or Sale of Business. The agreement should prescribe the steps to be taken to legally dissolve or sell the business. What percentage of ownership vote will be required?

11. Amendments to Agreement. What type of vote is required to modify the Founder’s Agreement? Some changes may only require a majority vote and others may require a unanimous vote.

12. Dispute Resolution. How will disputes be handled by the parties? My personal preference is to require confidential binding arbitration between the parties before an arbitrator. This can avoid lengthy and costly litigation that becomes public domain.

A solid co-founder agreement helps you avoid future problems

A well-thought-out co-founder agreement spells out the roles, responsibilities, and rights of the founders of a start-up company. The agreement can be the key to avoiding misunderstandings and providing a manageable dispute resolution process. You can’t just get a “model form” online and fill in names. You should write it with your specific situation in mind, with the help of a start-up lawyer or a credible online legal support service.

Copyright © by Richard D. Harroch. All rights reserved.

About the Author

Richard D. Harroch is managing director and global head of mergers and acquisitions at VantagePoint Capital Partners, a San Francisco-area venture capital fund. See all his articles and his complete biography on AllBusiness.com.

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