Essential Pre-Requisites of a Founders Agreement | Lawyers Advice in Delhi NCR | Corporate Law Attorney in Delhi NCR | Corporate Lawyer in Delhi NCR |

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As per the Indian government website of start-up India, India ranks 3rd as the largest start-up community in the world with about 50,000 start-ups in India in 2018 itself. With such a staggering number for a start-up and the interest of people to work independently, it becomes imperative for them to not only work on the ideas to set up the foundation of any business but also to protect themselves from any legal troubles in future. Hence, amongst the first thing to consider before stepping into the nitty-gritty of a business is to have a solid legal backing in the form of a founders agreement to start with. It is not uncommon to get into business with friends, family, or relatives. The problem which one might not think in the beginning or the notion that since it is business which is carried on with close ones hence there will always be a mutual understanding with regards to any aspects of the business has to be busted as there could be several problems that might arise which could put the founders and the members of the company into serious jeopardy.

Hence, before starting any form of business it is important to take sound legal advice and have a discussion with all the founders of a business and consider some of the important aspects to draw up the most basic agreement before starting any business i.e. a founders agreement. It is pertinent that all the founders of the business are well aware as to their roles, designation, and responsibilities in the business. Not only that the major problems that arise majorly are due to money issues hence it is important to discuss the various clauses and points like what would be the capital contribution of each founder or the equity contribution in the business. Hence, below are some of the important pre-requisites of a founders agreement to be considered before entering into any agreement with the founders of a business.

Essential Pre-Requisites of a Founders Agreement:

1. Individual Functional Roles & Responsibilities- It is recommended before starting any business a thorough discussion about the scope of the business and the co-founder’s roles, responsibilities, duties, and obligations should be properly segregated e.g. who will manage finance, IT, operations, etc in order to avoid interfering in each other roles in the future which could create conflicts in the decision-making ability.
2. Place of Operating the Business- One of the important aspects of running a business is having the business in a strategically or at a centrally located place whereby it is convenient to hold meetings and other day to day business activities. Hence getting approval from all founding parties is crucial as it will involve capital for rent or purchase of the place of business.
3. Compensation/Profit Sharing/ Equity Distribution- On basis of the segregation made concerning the co-founder’s roles and responsibilities and also the equity contributed by each co-founder, the compensation and other employee benefits whether statutory benefits like health insurance, bonus, PF, etc or non-statutory benefits like educational facilities or transport facilities or the profit-sharing ratio can be decided. The agreement can also specify the periodical revision in the salary structure as per the performance or other contributing factors of the partners.
4. Intellectual Property Rights- Intellectual property is a great asset for any business which they can possess and as such the business must own its intellectual property exclusively. The agreement should have a specific clause mentioning that the co-founders will assign all their intellectual property in the name of the business automatically, this step will avoid any legal complexity in the future. There could be two types of intellectual property, one which is already existing in the name of the co-founders before forming the company for instance, in the form of any technical rights which may belong to the developers, and second, which will exist after the formation of the business. In both the scenarios, the business must have all the rights, assignments, and licenses in its name exclusively.
5. Non-Compete/ Non-Solicitation/ Confidentiality- A founder’s agreement must mention the non-compete, non-solicitation, and confidentiality clauses, and the same should be accepted and ratified by all the co-founders. In any business the main concern is about maintaining the confidentiality of all the important aspects of a business and the same is expected to be maintained by the employees of any organization which means that no information should be leaked to the competitors of the business at any time during the employment or after exiting the organization for at least the specified period mentioned in the agreement. In Saltman Engineering Co. Ltd v Campbell Engineering Co. Ltd (1948) 65 R.P.C. 203; [1963] 3 All E.R. 413), it was held that an act of infringement will lie for a breach of confidential information upon the defendant in case any confidential matter is discussed or used without the express or implied consent of the claimant whether directly or indirectly. In Hi-Tech Systems & Services Ltd. v. Suprabhat Ray and Ors. [AIR 2015 Cal 261), the court restricted the defendant from using the trade secrets of the plaintiff as there was a clear clause in the agreement prohibiting the defendant from using any secrets or confidential information of the business for 3 years from the date of termination. Also, with regards to the non-solicitation clause, it should be made clear that any solicitation or an attempt at influencing any clients or employees of the business is strictly prohibited after the termination of the employment from the business.
6. Market Vesting Rights/Cliff Period- The cliff period and the market vesting terms should be included in the agreement which simply means the period after which the co-founder’s will be eligible to buy back their shares in the business hence, for example, if the vesting period is for 4 years and the cliff period is of 1 year then if the employee leaves or gets terminated before 1 year then he will not be eligible to receive any shares whatsoever but if he stays for a minimum period of 1 year i.e. the cliff period then he will get 25% of his shares vested in the business after 1 year and after that every month he will get 1/48th of the shares vested.
7. Termination/Exit Clause- There could arise a situation whereby the services of any employee may have to be terminated whether with a cause or without any cause of action depending on the circumstances during the time. Hence the agreement should clearly state the provisions for such exit or termination of such employees including the notice period.
8. Dispute Resolution- More often than not when working in a business setup there accrues complexities which gives rise to disputes amongst the co-founders, hence having a good mechanism for dispute resolution saves the business time and cost for a legal battle. The business may choose to go for any of the dispute resolution mechanism like mediation, conciliation, or arbitration to resolve any issues which could affect the operations of the business.
9. Dissolution/Conditions on Transfer of Shares- What happens if any co-founder decides to quit the business? Will the business come to an end or will the other co-founders continue to run the business? The outgoing partner may ask for a share of the business that he has invested or he may decide to transfer his shares to a third party and such an arrangement may not be agreeable to the other co-founders due to the transfer of ownership. Hence it is important to lay out details in the agreement specifying the dissolution clause and the conditions on the transfer of shares. The agreement can state that if any co-founder quits then the first preference to accept or reject the shares of the outgoing co-founder would vest in the remaining co-founders hence the shares of the company will remain with the remaining co-founders and no third party will be able to claim ownership in the business without the consent of the other co-founders. In V.B. Rangaraj v. V.B. Gopalakrishnan AIR 1992 SC 453, it was held that in case parties want to enforce certain restrictions on the transfer of share it will be valid only when the same is articulated in the Articles of Association of the company, in case of the contrary the parties cannot be held liable in case they sell out their shares to the third party. Hence it becomes imperative to carefully chart out the business decisions and enforce the same in the written agreement like in this case Articles of Association.

 

It is thus highly recommended that before starting any business or venture, the people involved in such business should enter into a founders agreement, and even if they have skipped entering into such an agreement, they can create one with retrospective effect to avoid any misunderstanding or other disputes in future which would save the business and the co-founders a messy legal battle.
Authored By: Adv. Anant Sharma & Emilia Chettiar