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Inducting a New Co-Founder in a Private Company

August 9, 2016

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In this blog post, Mrinal Litoria, a student pursuing his BA LLB from Rajiv Gandhi National University of Law, Patiala and a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, provides advice to a private Company who wants to induct a new co-founder.

What is a Private Company?

A private company may be one whose shares are not offered to the public for sale and are privately held by the founder or co-founders. Also, a private corporation may work with legal requirements which are less strict that those of public limited companies.

Who is a Founder?

A person who is the brains behind the conception of an idea for business, which he might want to start alone or with the help of other co-founders, and also venture into the implementation of the concept, may be called a founder. The concept or idea may be for-profit or non-profit purpose but what is important is that the mere conception of the idea will not make him a founder, something has to be founded upon the idea, i.e., the idea must be materially executed to make him a founder.

Who is a Co-Founder?

A founder does not necessarily have to be working alone on his conception or that the idea might not always be entirely his. There may be situations where an idea may be conceptualized by two or three or more persons, or that after the conceptualization of an idea the founder may feel like he needs additional people or their particular skill-set at the very core of it and moreover goes on to find somebody who believes in his idea and wants to put in equal effort in transforming the idea into reality, is the person capable of being called a Co-Founder. This person is equally involved with others in materializing the idea into reality.

Inducting a New Co-Founder

In a scenario where a private company has been incorporated by a founder or a couple of co-founders, the existing set of founders might feel like adding to their strength at the core of the company by inducting or recruiting a new co-founder, who might be able to take the company’s operations ahead in a better or organized manner. The company might want to recruit this new co-founder because they want to incorporate in their company his particular professional expertise for the benefit of their company. There may also be a situation of there being a vacancy in the position of a co-founder of a company for various reasons. In all such circumstances a private company can go on to recruit a new co-founder by entering into an agreement with this person (whom they are looking to recruit) for the decision of percentage of share that he would own, or other details about control or management, which is called a Co-Founders Agreement.

But certain essentials are to be pondered upon before entering into a co-founders agreement, which may be –

In the case of a registered company, the articles, and memorandum of association have to be looked into for deriving the power to induct a new co-founder, which, if is not present, an amendment to this effect has to be made.
There also might be a co-founders recruitment clause in the original co-founders agreement, specifying the rights and duties and even the method of inducting a new co-founder.
A private company may have another pre-decided procedure, criteria or panel for deciding upon the issue of recruiting a new co-founder as and when the need for such arises.

Co-Founder Agreement

A Co-founder Agreement is a contract between Co-Founders setting out the ownership, initial investments and responsibilities of each Co-Founder. This agreement also safeguards in the case of a dispute, as it can provide protection to show what the co-founder agreed too. A co-founders agreement may have provisions and clauses related to the following topics-

Co-Founder details
Project Description
Equity breakdown
Capital contributions
Roles and responsibilities of each Co-Founder
Management and approval rights
Non-compete clause
Confidentiality clause
Provisions relating to intellectual property
Provisions relating to Removal, Resignation, Dissolution and Termination, etc.

Steps Involved in Inducting a New Co-Founder Post Incorporation:

The mere signing of a co-founders agreement is not enough for inducting a new co-founder unless the agreement is comprehensive enough to cover all the issues involved in such induction like issuing of shares, IP assignment, etc. That is to say either for every issue a different legal document may be signed, which is usually the practice, or that such a set of documents which finally decide upon all the issues may be collectively referred to as a Co-Founders Agreement.

Upon incorporation the directors of the company are mandated to issue shares to the founders of the company, similarly, when there is a situation of inducting or recruiting a new co-founder, shares or stocks are to be issued to him in one way or the other. This can be done by some ways, i.e., by the existing founders selling some of their shares to the new founder or by having the company issue new shares and selling them to the new founder at fair market value etc. Therefore a restricted stock purchase agreement is to be signed by the new founder who in turn gives the company the right of first refusal in case of a proposed transfer or otherwise.

Then there might be issues of intellectual property assignment, and further documentation may need to be followed up with that. IP comes in many forms but make sure that whatever IP is being developed for your new enterprise belongs to the entity and not the individuals behind the development of the IP. This concept extends to not only co-founders but to all employees, consultants, and contractors.

The basic idea around which the concept of adding a new co-founder revolves is the issuing of ‘Founders Stock’ to the new co-founder and the legal formalities to be followed about the same. This does not have to be a specific kind of stock which is to be issued distinctively, but any stock of shares which is issued to the new founder may be called as such.

Therefore, it is to be kept in mind that a strict co-founders agreement is to be formed for the protection of interests of the company with having all the necessary non-compete and confidentiality clauses. Inducting a new founder can be a very sensitive issue, and there should be unison in the minds of all the existing founders and directors of the company. The issuing of shares to the new co-founder is the central step involved in the procedure which should thereby be carried out by a strict share-purchase agreement between the new founder and the company or between the existing holders and the new founder.

The followingnserves as an example for a co-founder’s agreement:

CO-FOUNDERs AGREEMENT

The Company

This agreement governs the partnership between the Founders, doing business as [company name] (the “Company”). The Company will continue perpetually unless dissolved in accordance with this agreement. The Founders will cause the Company to register its fictitious name in the jurisdiction where it conducts its business, as soon as reasonably practicable after the date hereof. The Company’s principal office address will be set by a majority of Founders, and initially is: [address].

The Founders

The following individuals are hereby admitted as partners in the Company (“Founders”)

[Founder] [Contacts]

The Project

The Founder is inducted whereby the founders have created the Company for the sole purpose of [description of the project] (the “Project“).

Initial Capital

Each Founder hereby commits to contribute up to $[____] toward Company expenses when called by the Company, as non-refundable capital contributions. The Company must make capital calls of Founders on a pro rata basis.

Additional Capital Contributions

The Founder may make additional capital contributions in the form of cash and prepaid expenses from time to time to fund the Company’s ongoing capital and operating needs. The written consent of all Founders is required for any Founder to make a capital contribution. No Founder may be required to make a capital contribution except under such mutual written consent.

Ownership of the Company

Each Founder will have an equal ownership interest in the Company. The Founders’ ownership interests need not be represented by a certificate or any other evidence beyond that contained in this agreement. If a Founder requests, the Company will issue a certificate evidencing the Founder’s interest. The certificate must contain a legend noting that the ownership interest is subject to legal and contractual restrictions on transfer.

Distributions

The Company may (but is not required to) make ordinary distributions to the Founders out of cash received by the Company (excluding new capital contributions or loans), less all accounts payable and reserves against anticipated expenses from time to time as determined by a majority of Founders. All distributions must be made in the following order:

First, in equal proportion to all Founders who have contributed cash that has not been repaid, until each Founder has been paid out to the extent of such contributions in full;
Second, to all Founders in equal proportion.

Management and Approval Rights

The Company will be managed by the Founders, and a majority of Founders may take any action on behalf of the Company except where explicitly stated otherwise in this agreement. The unanimous written approval of all Founders is required to:

incur any debt on the Company’s behalf or employ its credit;
liquidate or dissolve the Company, or distribute substantially all of its assets and business;
enter into any inbound or outbound license, transfer, or other assignments of protectable intellectual property used in the Project, including any patentable inventions, copyrights, trade secrets, or trademark rights;
approve any contract with a Founder, or an immediate family member or domestic partner of a Founder, or an affiliate of any of the foregoing persons;
raise any equity capital in any amount from any person;
admit any partner to the Company; and
amend this agreement.

Duties to the Company

The Founders must refer to the Company, in writing, all opportunities to participate in a business or activity that is directly competitive with the Project within [geographic region], whether as an employee, consultant, officer, director, advisor, investor, or partner.

Other than as explicitly provided herein, no Founder will have any duty to the other Founders or the Company, including any fiduciary duty, and including any duty to refer business opportunities to the Company, or to refrain from engaging in activity that is competitive with that conducted or planned by the Company.

Project-Related Intellectual Property

“Project IP” means:

(a) contributions and inventions, discoveries, creations, developments, improvements, works of authorship and ideas (whether or not protectable under patent, copyright, or other legal theory) of any kind that are conceived, created, developed or reduced to practice by any Founder, alone or with others, while such Founder is a member of, or provides services to, the Company, regardless of whether they are conceived or made during regular working hours or at the Company’s place of work, that are directly or indirectly related to the Project, result from tasks assigned to a Founder by the Company, or are conceived or made with the use of the Company’s resources, facilities or materials; and (b) any and all patents, patent applications, copyrights, trade secrets, trademarks (whether or not registered), domain names and other intellectual property rights, worldwide, with respect to any of the foregoing.

The term “Project IP” does not include any inventions developed by a Founder entirely on such Founder’s own time, without using any Company equipment, supplies, facilities or trade secret information, unless the invention related to the Project at the time of the invention’s conception or reduction to practice.

Each Founder hereby irrevocably assigns to the Company all right, title, and interest in and to all Project IP owned by such Founder. Each Founder agrees (i) to assist the Company from time to time with signing and filing any written documents of assignment that are necessary or expedient to evidence such Founder’s irrevocable assignment of Project IP to the Company; and (ii) to assist the Company in applying for, maintaining, and filing any renewals with respect to Project IP anywhere in the world, in each case at the Company’s expense.

Confidentiality

The Founders agree to keep all non-public information with respect to Project IP confidential and not to disclose it to any other party, except (i) to attorneys and advisors who need to know in connection with performing their duties, (ii) to potential business development partners and/or investors approved by the Company in writing, and who are bound by a confidentiality agreement in writing, and (iii) in response to an inquiry from a legal or regulatory authority.

Resignation and Removal of Founders

Any Founder may resign from a partnership in the Company for any reason or no reason at all by giving written notice to the other Founders. A majority of Founders may remove a Founder from the partnership at any time, for any reason or no reason at all, by giving written notice to such Founder. Upon a Founder’s resignation or removal, the Company will continue and will not dissolve, so long as at least one Founder remains as a member of the Company.

If only one Founder remains a partner of the Company at any time, then the Company shall continue as a sole proprietorship of the remaining Founder until he resigns, without affecting any rights due to any Founder or former Founder under this agreement.

If no Founder remains as a partner of the Company at any point in time, then the Company will dissolve, and this agreement will terminate immediately upon completion of the winding up of the Company and distribution of its assets and liabilities in accordance with this agreement.

Dissolution

If the Founders determine by unanimous consent to dissolve the Company and wind up its affairs, or if the Company dissolves because no Founders remain as partners, then any persons who were Founders immediately prior to the dissolution event will cause the Company to sell all its property (including Project IP) for cash only, and to liquidate in an orderly fashion. All Founders must be afforded a full opportunity to bid on any Project IP in connection with such liquidation process. The Company will distribute any property that remains after paying for the expenses of dissolving and winding up, and repaying all indebtedness owed by the Company, as follows:

First, in equal proportion to all Founders who have contributed cash that has not been repaid, until each Founder has been paid out to the extent of such contributions in full;
Second, to all Founders in equal proportion.

Title to any Project IP that is not sold in connection with dissolution and liquidation of the Company must, however, be distributed to all Founders as owners in common.

Dispute Resolution

All disputes arising from or related to this agreement must be submitted for binding arbitration before a single arbitrator under the rules of the American Arbitration Association as in effect at such time. The location for such arbitration will be New York, New York. The arbitration shall be subject to the supervision of the jurisdiction of Indian courts.

Miscellaneous Provisions

Assignment. This agreement may not be assigned by any party hereto without the written consent of all Founders.

Successors / Assigns. This agreement shall be binding upon and inure to the benefit of the Founders, the Company, their successors, and their permitted assigns.

Notices. Any notice or other communication required or permitted under this Agreement may be addressed to the recipient at its address given above or such other address as that party may provide from time to time, and shall be deemed duly given (A) when delivered, if by hand delivery; and (B) if otherwise delivered, when written confirmation of receipt thereof is obtained (i) from the recipient; or (ii) from a nationally recognized mail carrier.

No Third-Party Beneficiaries. Each party hereto intends that this Agreement shall not benefit or create any right or cause of action in or on behalf of any person other than the parties hereto, except as explicitly provided otherwise herein.

Amendment / Waiver. This agreement may only be amended with the written consent of all Founders, and none of its provisions may be waived except with the written consent of the party waiving compliance.

Governing Law. This agreement shall be governed by and construed in accordance with Indian laws applicable to contracts signed and to be performed solely within this state.

Severability. If any provision of this Agreement is held to be invalid or unenforceable in any jurisdiction, the validity and enforceability of all remaining provisions contained herein shall not in any way be affected or impaired thereby, and the invalid or unenforceable provisions shall be interpreted and applied so as to produce as near as may be the economic result intended by the parties hereto.

Signature

By signing below, each Founder indicates acceptance of the terms of this agreement in their entirety as of the date first written above, and represents and warrants to the Company and each other Founder that he has fully read and understood this agreement, and that to each Founder’s knowledge, no law or third-party obligation would prevent each such Founder from entering into and performing this Agreement in full.

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[1] The Sample Co-Founder’s Agreement has been taken from: https://www.docracy.com/6348/founders-agreement-template