In my previous article, “Demystifying the Startup Lawyer: What They Do and Why You Need One”
, I have explored and answered the questions —- What does a Startup Lawyer do and Why a Startup Needs a Startup lawyer? In this article, I will discuss some key issues that startup founders should know and how they could avoid common pitfalls.
But first, let’s define what a founder is
A founder is someone who creates or co-creates a new business venture, usually with a significant ownership stake and decision-making power. Founders are typically involved in the initial stages of product development, fundraising, hiring, and setting the vision and strategy of the company.
As a founder, his or her first job is to get the first thing right because one cannot build a great company on a flawed foundation. To do that, founders must know certain rights and responsibilities that come with their role. For example, founders have the right to:
- Share in the profits and losses of the company
- Participate in the management and governance of the company
- Receive information and reports about the company’s performance and financial status
- Transfer or sell their shares in the company (subject to certain restrictions)
- Sue or be sued on behalf of the company
On the other hand, founders also have the responsibility to:
- Act in good faith and the best interest of the company
- Disclose any conflicts of interest or potential liabilities that may affect the company
- Comply with applicable laws and regulations
- Protect the intellectual property and confidential information of the company
- Honor any contractual obligations and fiduciary duties to investors, employees, customers, and other stakeholders
Balancing the two has become among the most challenging tasks for all founders. Founders must learn how to structure their relationships with their co-founders and investors. There are many factors to consider, such as:
- How to divide equity among co-founders
- How to allocate voting rights and control over key decisions
- How to resolve disputes and disagreements among co-founders
- How to raise capital from investors and what terms to accept
- How to protect your interests in case of exit or dissolution
Simply put, these issues can make or break a startup. Hence, it is crucial to have a clear and written agreement that covers all the relevant aspects. In this regard, a founders’ agreement is a legal document that defines each founder’s roles, responsibilities, expectations, and obligations. It also outlines how equity will be distributed, how decisions will be made, how conflicts will be resolved, and how changes in ownership will be handled.
A founders’ agreement can help avoid misunderstandings, disputes, and lawsuits among co-founders and investors. It can also provide clarity and guidance for future scenarios that may arise as your startup grows and evolves.
At this juncture, it is apt to address the common confusion between founders’ and shareholders’ agreements. There is often much confusion between these agreements and at what stage one should have such an agreement in one business. And it doesn’t help that sometimes these terms are used interchangeably!
A founders’ agreement is simply a form of shareholders’ agreement used at the initial stage. It will usually be replaced by a shareholders’ agreement when the business takes on more shareholders.
However, always remember there is no “one-size-fits-all”, and the legal implications of various terms must be considered on a case-by-case basis concerning the number of shareholders, the relative size of their shareholdings, and even their respective financial strength. Only include provisions in a Shareholders’ Agreement after fully understanding how they work in the context of your particular business.
Thus, drafting a founders’ agreement can be complex and time-consuming, so it is advisable to consult a lawyer who specializes in startup law and can help you tailor your agreement to your specific needs and goals.
In short, startup law is vital to founding a new business; in that sense, it should not be overlooked or underestimated. By understanding your rights and responsibilities as a founder, having a clear and written agreement with your co-founders and investors, and seeking professional legal advice when needed, you can minimize risks and maximize opportunities for your startup.
To quote Peter Thiel, “A startup messed up at its foundation cannot be fixed.”
As such, founders should rightly treat legal fees paid to their lawyers as investments rather than costs. And it definitely does not pay to be penny-wise but pound-foolish!