Starting a new business is an incredibly exciting adventure. While there are countless different issues that need to be handled beforehand, there is one area that is often neglected: delineating the relationship between different founders. In the rush to advance the business itself, there may be cut corners as it relates to ensuring those involved in a venture have safe, secure legal understandings between one another.
For this reason, founders of a start-up enterprise must be vigilant about memorializing various items in a Founder’s Agreement. This is an absolutely critical initial step that should obviously be created in conjunction with a legal professional.
Perhaps most notably, the “initial capital structure” of the company needs to be settled upon right away. Potential shares must be allocated equitably based on initial contributions. This is not necessarily as easy a calculation as it sounds. While in hypotheticals it always breaks down evenly by percentage contributed, it is often difficult to determine projected contributions. For example, while one founder may provide more capital initially, the team could be under the assumption that all will ultimately contribute equally. This might counsel toward equitable distribution of shares. But everything in equal pieces is not the only option, and alternatives might be worked out depending on expectations. All of this must be determined on top of items likes buyback rights, restrictions on share transfers and so forth.
Ensuring Long-Term Commitment
One issue that commonly comes up in these agreements relates to essentially enforcing long-term commitment by the founders via forced “vesting.” In other words, if a founder holds unvested shares, they are only earned over time. If for whatever reason those shares are not earned, then are bought back. By voluntarily having founders’ share subject to vesting, the founders are incentivized to remain connected for their own maximum benefit.
This is a somewhat complex aspect to Founders Agreements, but in general, it should be noted that there are different ways to handle vesting issues. The vesting can be based on a specific time or a specific business achievement or “milestone.” Determining what is right for your business depends on the founders specific concerns. If commitment for the long-haul is desired, then a time based system might be appropriate (usually a period of years). However, if the business is suited for achieving very clear objectives, then it might make sense to base the scheme on achieving some notable goal. In fact, a combination of time-based vesting and performance-based vesting might best meet your needs.
Don’t Go It Alone
Figuring out these issues from the outset it one of the most important things that any new startup will encounter. It is important not to cut corners but instead focus on getting the legal help you need to do it right. In the Sacramento area, please contact the our business attorney for the guidance you need.