4 Key Terms to Agree with Your Co-founder
The first follower is what transforms the lone nut into a leader.
- Derek Sivers, the co-founder of CD Baby
Idea, tick! Research, tick! And then what?
I hope you are not thinking of doing it alone! A co-founder can make or break your venture and it is very easy to get it wrong. Don’t worry though, even the biggest entrepreneurs get it wrong sometimes.
Take Steve Blank for example. The cause of his biggest failure was a mismatch between the founding team and the business model. He did not have a co-founder who was a gamer nor anybody that had worked in a game company in his exec team. It resulted in $35m loss for Rocket Science Games. You can read more about his story there:
Now, you think you found the right person to kick-start your business and you are super excited. Yet, there is one very important thing that you need to reflect upon:
When you are getting married, think about the divorce.
This may be a cynical view but reading this article you will realise that you need to look ahead and understand:
(a) what would happen if things go wrong; and
(b) how to minimise any damage resulting from a fall-out and a dispute between co-founders.
The best tool available is agreeing a ‘covenant’ and writing it down. This would be your founder’s agreement:
The founder’s covenant
You need to set out the understanding and agreement between you and your co-founder on several things. It does not have to be a long document but it needs to address certain key areas.
The following are examples but you need to think of and cover many more in such a document!
You need to set out how decisions will be taken. The most critical thing to include is what happens if there is a deadlock. Will there be one founder who can overrule the other? If so, will it be in all areas or only in relation to specific ones? e.g. within his/her areas of expertise and responsibilities?
The other area that you need to cover in the agreement is what happens if one of you exits the business and on what terms?
The agreement will need to include what we call “good leaver” and “bad leaver” provisions.
A good leaver would, for example, be a co-founder that wants to exit because he/she got sick and cannot continue with the venture. In the case of a good leaver, the good leaver will not get penalised and the company would have the right to buy back his/her shares at fair market value.
A bad leaver would, for example, be a co-founder that he/she is simply not pulling his/her weight. In the case of a good leaver, the company would have the right to buy back his/her shares at their nominal value or lower.
3. Drag-along rights:
You should include these rights to prevent a minority founder holding a fundraising deal hostage. For example, you have 3 founders and an investor willing to put money in for equity. Founder 1 and founder 2 want to sell their shares to the investor whereas Founder 3 doesn’t. Using drag-along rights, founder 1 and founder 2 can force founder 3 to also sell his/her shares under the same terms/amount as their sale to the investor.
4. Tag-along rights.
These rights protect the minority founders. For example, Startup Inc. with 2 founders raises a few million from a VC. The VC now owns 60% in Startup Inc. and the 2 founders together hold 40%. After 4 years, the VC wants to exit and sell his 60%. The buyer offers to buy the VC’s shares at a very good price. Not wanting to miss out on this very good opportunity, the tag-along rights will enable the minority founders to join the sale and exit Startup Inc. at the same time as the VC and sell their shares on the same terms.
In summary, the key take-away point is better to be safe than sorry. With a little bit of planning ahead, you will have a lot less headaches later on and you can focus on your venture.
This article is written by Emmanuel Vranakis who is a technology & IP lawyer. He has worked with vendors and buyers of technology products & systems ranging from enterprise software businesses like Apigee (Google), buyers like Wm Morrisons plc, to SMEs and tech start-ups like PlaceMake.io.
He is also a co-founder of Jotup (Research Semantics), an NLP tech start-up. Emmanuel is committed to building our technology & content ecosystem and partnerships.
Connect with him on LinkedIn!
Some footnotes from the man:
The views are entirely my own. This article is for general information purposes only and does not constitute legal or professional advice. It should not be used as a substitute for legal advice relating to your particular circumstances. Please note that the law may have changed since the date of this article.