
6 Tips On How To Structure Founders’ Relationships To Avoid Future Strife
I am Ekaterina Igoshina, the founder of DealDep.com, a service which helps owners of businesses (shareholders) manage their relationships. As a legal specialist, I have seen a lot of entrepreneurs who had corporate conflicts with their co-owners. I suggest founders negotiate and fix (having agreed) at least these six matters below as early as they can.
9 out of 10 startups fail. That does not mean that startups are risky. It means that startup founders make similar mistakes that lead to the failure. Most entrepreneurs, inspired by a promising idea, never think that they could add to the staggering statistic of failed startups. They dive into working on their product at a fast rate while missing one of the most critical mistakes: setting up a founders agreement.
Professor Noam Wasserman of Harvard Business School in The Founder’s Dilemmas: Anticipating and Avoiding the Pitfalls That Can Sink a Startup says that 65% of high-potential startups die because of conflicts between founders, mostly caused by unclear expectations and responsibilities of the parties. This article underlines basic issues which founders should agree on before starting a new project in order to avoid serious disputes and corporate conflicts in the future.
1. Equal share does not mean fair share
Equity allocation is challenging because it is difficult to place a value on the different contributions required to create a company. There are no predefined formulas, so typically the following three variables are taken into account when deciding the distribution of shares: capital injection, time commitment, and value added. Each equity share should be equal to the contribution to the startup, taking into consideration both material and non-material inputs. As equity is being allocated for the startup, it is also important to have a plan for the event of a founder leaving the company. One of the ways to protect yourself is creating a vesting schedule, which means that shares are earned over time. All shares that were not vested before a founder leaves, are subject to repurchase by the company.
2. Founders` roles and responsibilities
In the early stages of your startup, you should assign roles and define basic responsibilities of each founder to ensure collaboration while avoiding repetition of work. The responsibilities tend to fluctuate and transform over time, but it is essential to outline the general guidelines of each formal role. Defining a job scope also means agreeing on the nature of employment conditions such as compensation and time commitment.
3. Appointing directors and decision-making
A founders agreement articulates the appointment/removal procedures, rights, and responsibilities of the Board of Directors and the management team. It spells out the rules for assigning the CEO and the limitations of his or her authority. A founders agreement should establish how both simple and substantial decisions will be made. Typical voting options include majority, qualified majority or special majority, and unanimous; it is common to have categories of decisions be subject to their own voting policy. Bringing in a third-party mediator could also be a good option to reach an agreement without going to court. Businesses should not be destroyed solely because the founders cannot agree on some issue, so a predetermined mechanism to resolve deadlocks is essential (such as mediation or consultation). In the event of a deadlock, it is helpful to have a clear mechanism of conflict resolution that is fair to all founders, with clear guidelines and agreed-upon rules to avoid uncertainty and suspension of the project activities.
4. Transferring shares to third parties
One of the most important parts of the agreement are the rules of transferring shares to third parties in the event one of the founders decides to sell his/her shares. Clear rules are required to prevent parties with conflicting interests from obtaining the shares. If you decide to allow the transferring of shares, it is a common practice to include a Right of First Offer, which obliges the founder to first offer the shares to the other interest holders, and only if they are not interested in the purchase is the founder allowed to sell to third parties.
5. Valuation of your business
Even at the very beginning of the project, it is a good idea to agree upon an approach to evaluating the company. It is important for two reasons: 1) if one of the founders decides to leave and the rest of the founders need to buy out his or her shares, 2) if you receive a new angel investment and need to determine how much equity to give out to the investor. Most smaller companies are valued based on one of the four methods: market approach — sales based, market approach — profit based, income approach, and asset approach. These methods help you, at any time, understand the worth of the project and the worth of everyone`s shares. Typically, they will result in different valuations, so it is necessary to agree on one method and consistently use it.
6. Avoiding conflict of interest
Non-compete agreements could be a part of your founders agreement or could be signed separately. They are promises between the founders to not compete against each other and to not use the intellectual property (IP) of the project outside the scope of the company’s activities. It is important that IP ownership is assigned to the company and not to one of the individuals. Clearly state the restrictions on financing of similar projects to prevent founders from engaging in activities that are in conflict with the objectives of the company.

