As a lawyer who specializes in working with tech startups, I help young companies make strategic decisions and prepare for growth. Frequently, however, I help clients untangle legal messes unknowingly created at their business’ inception. Of course, legal matters are complicated and mistakes can be made. But there are easily avoidable mistakes I see made over and over again that can imperil a promising business’ future. One of those mistakes is a business with multiple co-founders operating without a founder’s agreement.
A founder’s agreement is a document that creates the framework of your partnership.
It outlines each co-founder’s duties and establishes a decision-making process and protocol for mediating disputes. This is critical because as your business grows, things will change and unforeseen circumstances will likely arise. Disputes between co-founders can form for any number of reasons, from differences in work style to disagreements over who owns what percentage of the business to diverging long-term strategies. If this happens, a founder’s agreement will guide you as you work through your differences and therefore lessen the chance of jeopardizing your business’ future.
A very public example of what can go wrong without a founder’s agreement has been unfolding in recent months at Snapchat, the popular photo sharing app.
Snapchat has made headlines for the jaw dropping sums reportedly being offered for its acquisition. But the company has also been in the news for a legal battle between the company and its investors and a man claiming to be a third co-founder.
Reggie Brown was a classmate and close friend of Snapchat’s two co-founders, Evan Spiegel and Bobby Murphy. He was the originator of the idea behind Snapchat, and worked side-by-side with the co-founders during the company’s initial stages. At some point, however, it has been reported that there was a falling out between the men and allegedly Reggie was pushed out of the company. He is suing the company and its investors, claiming that his work in launching the company amounts to an ownership stake in a company that is now being valued at between $3 and $4 billion.
This is an extremely compromising position for a startup to be in. While it’s likely that Snapchat will survive this battle, most startups risk losing their investors should a major dispute between co-founders arise. A dispute between co-founders signals to investors that your company is unstable and isn’t prepared to grow. And it puts the investors themselves at risk. The Snapchat situation may have been avoided if from the beginning Snapchat’s founders had laid out their roles and expectations in a founder’s agreement.
Here are some key topics that should be covered in a founder’s agreement:
Ownership and Compensation
Who owns what percentage of the business, how much is each partner contributing? How and when will you get paid?
Rights and Responsibilities
What duties will each person be required to perform? How you will decide on certain business decisions? Will you require unanimous consent? Or will one person be able to make all decisions on behalf of the company?
How will you handle a settlement of disputes between the owners? What if there is a deadlock?
Restrictions on Transfer
Will you require an existing partner to offer to sell their interest to you before selling it to a third party? How will the partner’s value in the company be determined?
Death or Disability
What happens upon the death or permanent disability of a partner? Will you want the right to buy their interest in order to retain control of the company?
Protecting Business Goodwill
How will you protect your business? Do you want a restriction that prevents your partner from competing? Would you like to prevent each other from soliciting customers or new business from the company?
Conflicts between co-founders can arise even without the temptations of the tremendous sums at stake in Snapchat’s case. That much, at least, is exceptional. But what isn’t exceptional is the way that Snapchat began, like innumerable startups, as a few friends working together on an idea. Assuming friends would stay friends, they operated informally and without an agreement. Learn from their mistake and establish a founder’s agreement.
DISCLAIMER The content in this article is for informational purposes only and does not constitute legal advice. Readers should contact a qualified attorney to obtain advice with respect to any particular issue or problem.
Tricia Meyer is managing attorney of Meyer Law, a forward-thinking boutique law firm providing top-notch legal services to clients ranging from startups to mid-sized companies to large corporations in a variety of industries including technology, telecom, financial services, real estate, advertising, marketing, social media and healthcare.
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