In this article, Shringar Bhattarai pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses the Steps for inducting a new Co-Founder in a private company.

Among various forms of business organizations, a company signifies a body acquiring a unique character of being a separate legal entity. It is clothed with a legal personality to have its existence distinct and separate from its members. A company is an artificial person having perpetual succession and is unaffected by the changes in role of its members. A private company is a limited liability corporation having multiple ownership but their shares are not offered to the public and shall comply with lesser legal requirements than that of a public company. A private company may commence its business immediately after incorporation, it does not require to issue prospectus or hold statutory meetings and hence legal formalities are less onerous for private companies. A business plan highly depends upon how founders wishes to strategize, plan and manage complex, difficult and unforeseeable situations with their expertise. Before understanding the steps, it is appropriate to have known the meanings of relevant terms.

FOUNDER

Founder is the mastermind involved in the creation of a business or the mindset behind the inception of a business, who plays a vital role in laying the foundation and endows a quality, intelligence, asset or funding, independently or in assistance of co-founders. The idea or opinion originates from a founder and he shall further execute the emergence of such concept materially whether or not it is profitable, to be a founder. A founder is generally labeled with eminence for his implication of creativity and innovation, strength of will, insight and sense of fearlessness. He owns every risk and reward for the conception of idea into creating something from nothing. The initial ownership lies with the founder who works to bring in resources to build up an enterprise.

CO-FOUNDER

The idea of inception does not necessarily come from single founder or that founder may not be able to execute the same independently, thus, for the conceptualization of such ideas, a founder may require additional persons who joins the company as co-founders at the earliest stage and assists in financing, recruiting, strategizing, product development and mentoring. Co-founders have much deeper and focused involvement for a longer period of time. They bring in commitment and valuable experience for a highly potential start-up. A co-founder is equally involved in materializing the concepts and plays similar role as that of a founder in transforming the visualized idea into reality. Before incorporation, the idea may generate between two or more people who become co- founders or an additional person with skills to execute the idea may come forward as a co- founder. After incorporation, a co- founder may be introduced with a percentage of share that he would own and  duties of control and management, specified in the co-founder’s agreement, if the existing founders while exploring possibilities senses that an additional person with skilled knowledge and certain professional expertise is required to push the growth and development of the company or if the previous co-founder wishes to quit or retire or circumstances arise such that the responsibility and position remains vacant.

A private company may engage a new co-founder by entering into an agreement with that person, determining the percentage of share for him and his responsibility of control and management, called co-founder’s agreement. But certain essentials need to be reviewed before entering into such agreements with a new co-founder i.e. firstly, if the company is a registered company, articles of association and memorandum of association of that company may provide for power to induct a new co-founder and in absence of which amendment to this effect has to be made, secondly, there might be a recruitment clause in the original co-founder’s agreement, specifying the rights and duties and steps of inducting a new co-founder and thirdly, there might be an established procedure for recruitment of new co-founder as per the necessity.

CO-FOUNDER’S AGREEMENT

A co-founder’s agreement essentially governs the professional relationships between founders who have started a new business or who intends to implement their ideas into a new business. The purpose of agreement is to determine the functions of the company, relationships and obligations between co-founders legally binding through a formally written agreement.  It is extremely important for the co-founders to determine the terms of business and maintain a clarity by way of agreement in respect of investment and resources to operate professionally. The factors that is required to be undertaken are the foreseeable future goal of the business, time devoted by the co-founders, allocation of responsibility among co-founders and a profit sharing ratio among the founders.  The objective of the agreement is to minimize the possibility of disputes in future when the business is functional. It provides protection and safeguard to the core aspect of the business when the agreement requires an open discussion between the partners regarding the functional aspects.

A co-founder’s agreement must have following elements[1]:

Business Definition and Milestones: Defining potential venture of a company with clarity and establishing business terms is essential to prevent the exiting co-founder from engaging into competing business or using the brand name. A specific milestone may be described to determine the future potential in the idea.

Ownership:  The ownership element deals with the equity, percentage or number of shares held by each co-founder. Each co-founder’s contribution and role should be taken into consideration. The division of ownership may be done in the following manner:

• Rule of N: equal distribution among number of members.
• On the basis of efforts and capital contribution: it involves a consideration of the efforts made by an individual in working or through his capital contribution and division of ownership shares is made in its proportion.
• Vesting: granting of shares of company and right to buy back shares
• Departure and dis-ownership: In case of departure of founder, the agreement shall clearly determine the rights of the founder and there shall be limits upon selling away of the shares.

The conflicts may arise upon the distribution of profits in a business thus there must be clarity and definite specification in the agreement regarding the distribution of profits among the members.

Roles and Responsibilities: The co-founder agreement shall clearly determine the roles and responsibility of each member and its extent to avoid future conflicts among the founders. Any significant role to be designated to any individual in future must be decided from the very beginning. The decision making procedures should provide leverage for redefining roles at various stages if felt necessary. The founders though play a significant role at the very beginning by laying a strong foundation, they shall also define roles and responsibilities for role players of future to avoid conflicts and failure of business.

Firing a Founder: It must be addressed in the agreement that at which event and manner a founder must be fired. It is a crucial issue and there might be endless conflicts in future in the agreement does not lay down the circumstances to tackle such issues.

Decision Making: In order to avoid conflicts arising out of complex situation in the process of development of business, a co-founder agreement shall clearly mention how decision are to be made.

Conflict Resolution: An alternative method for settlement of disputes must be clearly mentioned if in case members aren’t able to resolve dispute among themselves. Predetermined conflict resolution procedure helps in proper functioning of the business.

Non-Compete:  This clause of is very essential in a business to ensure that any founder who steps out of the business would not compete with the original business. There shall also be a clause imposing obligation to maintain confidentiality regarding sensitive matters of the business. The existing founder shall continue to be faithful to the company by not attempting to solicit clients or employees of such company to another company.

Compensation: At the beginning of life of the company, it is essential to determine provisions for revenue, profits, compensation and reimbursement of expenses of the founders. These aspects are very sensitive as it involves rewards as well as risk, thus the provisions must be specified with clarity in the agreement.

Loan from Founders: The agreement shall clarify how the loans from founders are to be treated. Unless otherwise, mentioned in the agreement the founder’s loan must be paid back with interest or other benefits.

Induction of New Co-Founders:  It would be appropriate if the agreement provides for a clause mentioning the manner in which a new co-founder may be inducted and the extent of his role in the business.

Other Provisions relating to Removal, Resignation, Dissolution, and Termination, etc.

Although, the most essential step for inducting a new co-founder is formation of co-founder’s agreement, it cannot be said to be effective enough if it does not comprehensively cover over all aspects of the business. This agreement minimizes the legal inconvenience of signing various documents individually and collectively covers all aspects in one single document. The original agreement shall clearly specify in a clause the manner to be adopted when a new co-founder is to be brought into the company along with their rights and duties. A precise and literal agreement is required to be made before inducting a co-founder into the company as it is a sensitive issue and requires cooperation of the existing members with the new member. A private company shall form the agreement in such a manner that protects and safeguards overall interests of the company.

References

[1] https://www.linkedin.com/pulse/20140612075141-18771188-co-founder-s-agreement-basics-that-every-entrepreneur-should-know