03 Jul Legal Issues when building a Founding Team
Founding Team : Legal Issues
Apart from the obvious things like ensuring your co-founder(s) is someone you can work with (personality wise), and that the person brings value to the business, either by way of investment or by his/her skills, the most important thing from a legal perspective when you are deciding on building a founding team is that you must ensure that you have a Founders Agreement in place.
This Agreement is sometimes referred to as the Shareholders Agreement (if the business is registered as a limited liability company). This Agreement ensures that the running of the company and the responsibilities of the founders are well detailed and so it reduces the potential for conflict between founders and helps the company to be run smoothly and profitably
Most people when starting a business choose founders who are their friends, and while that is not such a bad idea, it always has the possibility to get messy further down the line, especially if one person feels the other isn’t pulling his/her weight or when one of the founders starts to lose the passion for the business.
Another issue here is how to decide on the ownership structure, should it be a 50/50 split or 80/20 or 60/40?, the answer is – it depends. Each founding team will have to decide for themselves, there are a few tools that you can use to guide you on how to share this, for example this tool. Ultimately though, whatever you decide on will have to be included in the founders Agreement. Key clauses that are covered in the Founders Agreement include:
Accession Procedure – this basically means the process which the founders agree to bring new people into the founding team. Must there be unanimous agreement? Is there a cooling off period when a new person comes in that the other partners have a right to change their mind and buy back the shares from the person? Etc.
Intellectual Property Assignment – what this basically means is that all the founders agree that as they are developing the idea, all the intellectual property in it will be vested in the company (and so technically it would be jointly owned by everyone). Not having this clause could mean that if there is one founder who is primarily responsible for developing the idea (especially in a technology business), then he/she could own 100% of the IP in the product and could therefore have a potentially unfair advantage over the others who are working on other equally important aspects of the business.
Share Vesting – Under these clauses, a founder does not obtain the full benefit of the shares he owns until certain conditions have been satisfied, such as remaining with the business for a minimum period of time or achieving a specific milestone. After those conditions are satisfied, the shares or a certain pre-determined percentage of the shares will “vest” in the shareholder. Otherwise, the company may have an automatic right to repurchase the shares.
‘Drag along’ and ‘Tag-along’ rights – Drag-Along clauses ensure that if a set percentage of founders wish to sell their shares to a third party, they can force the remaining minority founders to sell under the same terms, in order to ensure that the third party can receive 100% of the shares. Tag along rights on the other hand, require that if a set percentage of founders wish to sell their shares to a third party, the other founders can demand to be included in the deal to sell their shares. This ensures that the other founders are not “cut out of the deal”.
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