An introduction to Co-Founder Agreements
Starting a business with co-founders is exhilarating, but it can also be a leap into the unknown. When co-founders are aligned, things run smoothly. But what happens when opinions clash, someone wants out, or life throws a curveball? Without a clear agreement upfront, these moments can lead to costly disputes, potentially threatening the future of your venture. That’s where a co-founder agreement comes in.
What Is a Co-Founder Agreement?
A co-founder agreement (working alongside the articles of association) is a contract between founders that sets out who owns what, how decisions are made, and what happens if someone leaves.
From experience, founders often do not enter into one. It’s often overlooked because of costs and a focus on getting the business off the ground, which is understandable. Founders will also sometimes decide not to put one in place because they are about to raise funds, and typically a co-founder agreement is replaced by new documentation signed on the investment round. Again, this is understandable and makes logical sense. But if you anticipate a gap of more than 6 months between incorporation of your venture and your first funding round, having one in place is wise. It can prevent costly disputes and protect the business during its most vulnerable stage.
Who Signs It and Where Does It Sit?
Typically, all founders sign the agreement. However, some provisions belong in the company’s Articles of Association (a public document filed at Companies House), while others sit in the co-founder agreement (a private contract). For example:
– Provisions around share transfers and share rights should go in the Articles.
– Operational rules, restrictive covenants, and confidentiality terms fit better in the private agreement.
Key Terms
Here are the must-have clauses in a co-founder agreement:
- Equity Split: Set out how the shares are split between the founders upfront. Will shares be issued for cash, intellectual property, or nominal value? Typically, founders are issued shares at nominal value (e.g., £1). This can be heavily negotiated if there isn’t an assumed equal split.
- Decision-Making: Which decisions need the unanimous consent of the founders? Which decisions can be delegated?Big-ticket items, such as raising funds, selling the company, taking on debt, and changing the nature of the business should require all founders’ approval. Other day-to-day decisions can probably be taken by the founder who is responsible for the relevant area of the business, e.g., hiring within their team or entering into customer contracts below a certain threshold. If there are three founders, they may be comfortable with a 2 out of 3 majority on some of the decisions. Although you do have to ultimately ask the question as to whether the founder relationship is sustainable if one founder keeps voting differently from the other two. If one founder holds significantly more shares than others, it might make sense for that founder to have a veto on all material decisions.
- Non-Compete Covenants: Founders shouldn’t work for or invest in competing businesses during their tenure and for a reasonable period after leaving (typically 12–18 months). A founder could damage the business if they did this. Putting in place restrictive covenants help manage this risk, although it is sensible to also include similar covenants in the founders’ employment agreements.
- Confidentiality: Founders should agree not to disclose sensitive information without consent from each other.
Here are the must-have clauses in the articles:
- Leaver provisions: If a founder leaves the business in its early stages, then arguably they should be required to give some of their shares back. Is it fair that a co-founder who holds 50% of the shares gets to keep them all if they leave after 12 months because they decide that start-up life isn’t for them?Where they have resigned or leave in circumstances within an agreed period which are not damaging to the business, they should lose a proportional amount of their shares. This reflects their limited contribution to the business and the fact that they will not be around to help it grow. This is usually covered by including leaver provisions, where if a founder leaves within an agreed period (usually 3-4 years), a proportionate amount of their shares will be lost. For example, if they resign after 2 years, they lose 50% of their shares.
- Bad Leaver: It would also be sensible to deal with the scenario where a founder has left the business because they have significantly damaged its reputation or value. In these circumstances they might be deemed a bad leaver and should lose all their shares. This could be because they have committed fraud or gross misconduct or joined a competitor.
- Transfer Restrictions: You want your co-founder to be committed to growing the business. You may therefore consider including a provision which says that each founder cannot sell their shares for an agreed period of time (e.g., 2 years) without the consent of the other founders. If they do want to sell their shares following this agreed period, they should offer them to the remaining founders first, and if a founder does not take up this offer, they cannot sell the shares to a competitor.
- Death: Few founders want to think about this, but it’s critical. If a founder dies, their estate will likely want to benefit from the economic value of their shares. However, the remaining founders may not want unknown individuals holding a significant stake in the business and potentially blocking decisions. If a founder passes before the end of an agreed vesting period (as mentioned above), it’s not unreasonable that unvested shares are lost, as they won’t be around to help grow the business. For vested shares, there are a few options: –
- Buyout Rights: Remaining founders may have the right to purchase the deceased founder’s vested shares at fair value. It would be unfair to force a sale at significantly below market value.
- Non-Voting Shares: Allow the deceased founder’s shares to remain but strip voting rights. This allows their estate to benefit from the economic upside, but prevents individuals with no involvement in the business or relevant experience from influencing decisions.
- Insurance: Consider taking out life insurance on each founder to fund buybacks. This could allow the remaining founders to buy out the deceased founder’s shares for value. It is likely that the remaining founders will not have the funds to buy them out without this insurance.
With all these provisions, you want to think about it from both sides of the situation – e.g., whether you are the founder leaving or the founder staying.
Don’t Forget IP and Employment Contracts
Founders often create IP before incorporation of the new venture. Ensure all IP is assigned to the company. Employment contracts should also be signed early to avoid ambiguity over notice periods and pay.
Quick Checklist for Founders
– Equity split agreed and documented
– Decision-making rules defined
– Confidentiality and non-compete clauses included
– Vesting and clawback provisions in place
– Death terms agreed
– IP assigned to the company
– Employment contracts signed
Final Thoughts
A co-founder agreement and articles are not just paperwork – they are peace of mind. They set expectations, protect relationships, and help your business weather the unexpected. Skipping it might save costs today, but the cost of a fallout later can be catastrophic. If you want to build a high-growth business, make this one of your first steps toward long-term success.
