In this blog post, Aditya Arora, a fifth-year law student at Jindal Global Law School and pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, describes the disputes that may arise in a co-founders agreement with plausible solutions. 

A Co-Founders Agreement is a contract between the co-founders of an entity, laying down the ownership pattern, investments, their roles and responsibilities, etc. It is a legal framework safeguarding the interest of each co-founder in the case of a dispute. Therefore, when a dispute arises, the agreement provides protection by showing what the co-founders had agreed to at the time of inception of the entity. Though there are other legal instruments such as Articles of Association, Memorandum of Association etc. which too governs the relationship between the co-founders, the essence of this agreement is to develop an understanding amongst the partners with regard to the functioning and management of the company and thus making it legally binding on them through a written agreement. Therefore, the stronger and clearly written the agreement is, it will minimise the chances of a dispute occurring between the co-founders.

One of the famous co-founder disputes that came into the limelight was the Housing.com dispute where the Co-Founder and CEO Mr Rahul Yadav had a dispute with the board, followed by his resignation which was dramatically withdrawn. Later on, the CEO was ousted by the Board itself. Started by a group of 12 IIT Bombay Alumni, Housing.com got a funding of 750 Crores in 2015 from the venture capitalists and was deemed as a booming startup for the e-commerce industry in India. The main reason for the dispute amongst the co-founders was with regard to the power struggle in Housing.com that led to the resignation of 9 out of 12 original co-founders by 2016. It had a total of 12 co-founders out if which just two people had a permanent seat on the board. The issue here was with regard to the recognition of members as the control was in the hands of directors. This led to a conflict of interest amongst the co-founders generating friction in the management resulting in top-level exits. The co-founders didn’t enter into an agreement before starting the entity hence resulting in the mishap. A strong and clear agreement amongst the co-founders could have safeguarded their interest and could have averted the dispute that maligned the image of Housing.com and its co-founders. This example highlights the key disputed areas in a co-founder agreement which, if worked upon, could help the company sail thru any and every dispute it faces.

Another classic example of Co-Founder dispute was firing of Steve Jobs from Apple Inc., a brainchild of his own, where he was asked to quit the company pertaining to the differences between the Co-Founders Steve Jobs and Steve Wozniak. From the above-mentioned examples, the probable areas of conflict can be culled out from a co-founder’ agreement, and the suggestive clauses can be determined in order to minimise the co-founder disputes.

Preventing Co-Founder Disputes

One of the best ways to minimise the probability of co-founder dispute is by drafting a well-balanced agreement respecting the interest of all the parties to the agreement while laying down a dispute mechanism simultaneously. Though there exist Memorandum and Article of Association which usually governs the relationship between the stakeholders, it could take shape as company’s bylaws or a partnership agreement, etc. The clauses to emphasise on while entering into a Co-Founders Agreement in order to minimise the dispute are:

• Contribution and Ownership of Each Partner to the Firm: It is important to mention clearly the ownership pattern of each partner addressing the percentage and number of shares held individually. Depending upon the number of shares held, co-founders are assigned their voting rights which also if clearly mentioned could avert serious complications. In the case of Housing.com, the shareholding pattern with regard to the capital invested, the effort made by the partners was missing in the agreement. Also, no provision with regard to the vesting of shares was explicitly mentioned as such.
• Business Decisions:  In the benefit of the Company’s interest, it is essential to lay down a mechanism to take the decisions smoothly in order move forward. The decision-making power should be shared depending upon the shareholding pattern of each co-founder, but the mere presence of such mechanism can avert many future disputes. In Housing.com dispute, with a total number of 12 co-founders, only two were given recognition by the Board. Since they lacked the majority in the board, the decisions making mechanism had taken a hit. Therefore, if it is made clear in the co-founders’ agreement the decision-making power vested in every individual, it would be hassle free for the management to take decisions.
• In the event of Co-Founder leaving the Company or being fired: In case a Co-Founder wishes to leave the company or is being fired as a result of Co-Founder dispute, it is essential to mention the right that they will enjoy after their exit. Certain exit rights could be included in the Agreement in order to protect the company such as:
  • Right of First Refusal – A right of first refusal could be established giving certain parties an option to buy the shares being sold by the existing co-founder before offering it to a third party. In Housing.com conflict, Mr Yadav was certainly not obligated to offer his shares to the Board of offering it to a 3^rd party. Therefore, a strong exit clause from the agreement was missing.
  • Tag Along Rights – In the event where a Co-Founder exits the company, tag along rights could be given to the other Co-Founders, giving them the option to leave the Company on the similar negotiated terms.
  • Drag Along Rights – On a similar event of a Co-Founder exiting a company, drag along right could ask another Shareholder/Co-Founder to participate in the transaction.
• Intellectual Property: Equity distribution amongst the co-founders is based on the capital brought in by the founders as well as Intellectual Property brought in. Therefore, it is very important to set out as to what happens to the Intellectual Property that was brought in by the co-founders or was created during the course of business if he or she decides to quit the business. Therefore, to tackle this situation, the Intellectual Property Rights could either be assigned to the Company for a hefty amount, stake, etc. or could be licensed to the company on a royalty basis.
• Strong Dispute Resolution Mechanism: Even the above-mentioned clauses are taken care of with a strong Memorandum of Association in the backing; there are still chances of a Co-Founder dispute being raised. Therefore, there needs to be a strong and clear, predetermined mechanism for such dispute resolution which can resolve the issue quickly without causing any damage. For example, co-founders can decide to opt for mediation with a predetermined mediator to resolve any disagreement. Straight away taking the litigation path may hamper the company’s image thereby leading to losses. In the case of Housing.com, there was clearly no dispute resolution mechanism present, if any, therefore when the dispute escalated, the Co-Founder was left with no choice but to quit, twice. Mere difference in ideology, which can easily be resolved through mediation, witnessed 9 out of 12 co-founders exiting the company.

Conclusion

From the above mentioned key elements of a Co-Founders Agreement, not only the importance of a co-founders’ agreement can be highlighted, but a strong and clear drafting is strictly required in the interest of the company and to maintain peace and harmony between the Co-Founders. These are not only clauses that need to look into with caution as the agreement may differ from business to business and depend on upon the nature of business. It was one of the main reasons that led the hosuing.com dispute public. Even if in the absence of a  strong agreementbut had there been a strong and efficient dispute resolution mechanism present in the agreement, things wouldn’t have turned so ugly for housing.com.