This article is written by Maria Ana who is pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho.
Starting a new project is exciting and while negotiating the technical elements one may forget the legal and financial aspects or may take it for granted that everyone is on the same page. To help you along this exciting journey, here are some points that one should keep in mind while negotiating with your co-founder.
Important points to consider for Co-founders
- Plan of action
- What are the goals for the Company and what goals are the individuals involved?
- The timeline for the individuals involved in accordance with their goal. Timelines are important for these goals.
- Ownership structure
- The individual Co-Founder’s percentage of the company?
- The individual contribution of each Co-Founder to the company? (e.g. their duties, roles and responsibilities, job description, time commitments.)
- The capital each Co-founder will contribute and the purpose for which the contribution will be used.
- Share Vesting structure.
- Management of the Company.
- Decision making.
- Entitlement of salaries for the co-founders if any and how can it be modified?
- Exit strategy for any of the co-founders depending on their contribution.
- Rights of the remaining Co-founders if one of them leaves.
- Different situations such as an opportunity to sell the company, raising money, or dissolving the company.
- What happens when a Co-founder is disabled or dies?
- What if things do not go as planned. Is there a plan B.
- Should the Co-founders work exclusively for the company or are they allowed to work alongside with other companies and / or projects?
- Conditions for removal of Co-founder.
- Dispute Resolution
- Failure of business
It will be a smart decision for the Co-Founders to execute a Co-Founders Agreement during negotiations and before formation of the Company which discusses the above aspects at length.
A Co-Founders agreement brings together a business concept and creation of a new entity. The Co-Founders Agreement endeavors to cover and predict disputes that might arise at a later stage. It also bifurcates and creates rights, duties and obligations for the Co-Founders. The Co-Founders Agreement prevents the Founders from being caught off guard as the Company evolves.
At this juncture it is important to understand the different clauses that have a scope for negotiation in the Co-founders agreement.
1. Project to a Company: It is vital to set out a mutually agreeable timeline when the Project will be transferred to a Limited Liability Partnership/Private Limited Company/ Public Limited Company and if there is a delay, how long is the delay permissible.
2. Timeline: A timeline is necessary and should be clearly mentioned to reduce wastage of financial and other resources.
3. Capital: It is essential to be clear about the percentage of the initial Capital and subsequent investments for the Project. Also, it is important to allocate the use of the capital.
4. Transfer of ownership to company upon formation: With the above timeline in mind will the Co-Founders transfer and assign their right, title and interest to the Partnership or Company as agreed. That includes the intellectual property, ideas, labor, tasks performed by the Co-founders or the employees that relates to the Project. The Company may be considered formed upon registration and receiving the certificate of incorporation. It is important to consider the status of the Co-Founders once the Company is formed. Will they become Managers or will they be Directors.? Will they take on regular duties?
5. Ownership Structure: The percentage of the Co-Founders investment in the project is usually converted to shares when the Company is formed.
Further, the Co-Founders may choose to reserve any portion of the shares for future employees or for an option share pool, consequently it will dilute all the Co- Founders equally or as per the percentage of their investment.
The shares issued to each Co-Founder may be from the same or different class of shares therefore, one should clarify if there is a differences in the rights (such as voting and / or distribution rights etc.) accorded to the shares issued to each Co-Founder.
6. Roles and Responsibilities of the Co-Founders: One should consider the roles and responsibilities each Co-Founder should perform in terms of their ability and what they are ready to bring to the Project.
Questions like, should the Co-Founders devote their full time and attention to provide services to the project? Will the Co-Founders be allowed to undertake any work without the written consent of the other Co-Founders? What are the policies, rules and regulations of the Project which bind the Co-Founders?
The allocation of responsibilities may not be strict, and the activities may be shared between the Co-Founders and they may cooperate with and assist each other for the benefit of the Project.
7. Exit clauses: In the event of death, permanent disability, removal or resignation of a Co-Founder, it is important to consider these events and the impact it will have on the rights of the remaining Co-founders. The questions that arise are, how will a Co-Founder be removed? What are the grounds for removal or termination of a Co-Founder? What are the buyback rights of that Co-Founder’s share and the price? Will the venture end? Will one of the Co-founders be able to take the idea forward without the rest of the Co-founders?
8. Share Vesting Structure: One should be very clear about the type of Share Vesting Structure. There are two types of Share Vesting Structure – A Time Based vesting – where the shares will be vested in proportion to the time spent by the Co- Founders. Or Milestone Vesting – where the vesting will take place when the company achieves a milestone.
9. Decision making: It is also imperative to clearly lay out how the key decisions and day to day decisions of the business are made (e.g. by majority vote, unanimous vote, or certain decisions can solely be made by the Key executives?).
10. Contractual communication and dispute resolution: There are many circumstances in which a Project may be delayed. Should the Project exceed the timeline to transfer the Project to the Company the Co-Founders may agree to discuss if the collaboration related to the Project should be continued or terminated.
Should any dispute arise amongst the Co-Founders regarding the continuation or termination of the collaboration they may refer the dispute to a confidential mediation process at a place and to a mediator mutually agreed by the Co-Founders at the time of signing of the Co-Founders Agreement.
The Co-founders may agree to have the costs of the mediation to be borne equally by all Co-Founders. They may also waive any and all rights to have the Co-Founders Agreement adjudicated by a court of law.
11. Additional funds: Having the ability and flexibility bring in additional capital over and above the investment of the Co-Founders. Questions like, who can apply for loans? The amount of the loan? Which bank the loan should the Co-Founder take the loan from? How much interest should be paid? The duration of the loan and repayment structure?
12. Angel Investors: Bringing in Angel Investors before the formation of the Company for additional capital, the Co- Founders should consider how will the Angel Investor be compensated and will they have the same rights as the existing Co-Founders. Will the shares of the existing Co-Founders be diluted in proportion to the investment? Once the Company is formed will the security be in the form of Common Shares, Preferred Shares, or Debt.
The Co-Founders Agreement should be amended according to the agreement with the Angel Investor if brought in before the formation of the Company.
13. Intellectual Property: Intellectual Property (IP) refers to inventions, literary and artistic works, designs and symbols, names and images which are created. It is important and highly valuable. During the Project the Co-Founders or employees may create such intellectual property. The question that arises is whether the Intellectual Property is the property of the Project and /or the Co-Founders? How will the Intellectual Property be secured?
- Confidentiality: This is crucial for the success of the project. The Co-Founders should not disclose the Project, Business Concept and Technology to anyone outside until the formation of the Company. If it is necessary, it should be a written, unanimous, consensual disclosure amongst the Co-Founders.
- Visit a lawyer and a Chartered Accountant: It is good practice to seek independent legal and other advice. Do not use the same lawyer/and CA as your co-founder to prevent conflict of interest. It may be expensive but it will be worth it to avoid future disputes, as the project evolves.
To conclude, it is important to find the balance between flexibility and rigidity of one’s responsibilities, duties and obligations so that the project is successful. While negotiating it is vital to remove ambiguity and prevent dissolution, equity restructuring and breaches of contract that may occur in the future. Thus, these are some of the points to look into while negotiating with your co-founders.
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