Co-founder maybe your best friend, your next of kin or any close relative, at the beginning you may kick off really well but as the time will pass you would need to draw a line and form boundaries between the personal life and the professional life.
Even though you can still operate and manage your startup without any formal written Agreements, but there is always a risk in the long run, especially when differences arise between the founders with regards to running the business or any other account and at that point of time one always regrets not having executed written Agreements clearly spelling out the terms and conditions that we wish to put in place.
Co-founders’ agreement is a contract between co-founders of an entity, laying down the ownership pattern, investments, their roles and responsibilities etc.
WHY NEED A CO-FOUNDER AGREEMENT?
The agreement acts as safeguard to protect the interest of each co-founder in the case of dispute and also to develop an understanding among the partners with regarding the functioning and management of the company and thus making it legally binding on them through an agreement.
In case, a start-up decides to operate through a partnership, one must meticulously draft a partnership deed with an endeavor to encapsulate all situations beginning from the establishment up to the dissolution of the partnership.There are various essentials which are to be kept in mind while drawing up the co-founders’ agreement:
Definition of business as to defining the potential venture of the company:
1.Ownership that deals with equity shares and percentage or number of shares held by each partner. Co-partners have the pro rata voting rights in order to define ownership. Pro rata is the “share to be received or an amount to be paid based on the fractional share of ownership, responsibility, or time used”.In case there are different arrangements then veto power is considered instead. Veto power. Further, contribution and role of co-founders should be taken into account and it depends upon the investments made and the intellectual property bought.
The criteria for deciding the ownership can be defined by :
Rule of N: Division of interest based upon the number of founders.
Basis of effort or capital contribution: (whether financial, social, intellectual or any other kind)- This method is more suitable in terms of ‘fairness’. For example: if founder A has brought the idea and finance and Founder B has brought the ability to work hard and devote time then a greater proportion of economic interest can be in favor of Founder A.
Vesting: Conditions or circumstances under which the company gets the right to buy back shares should be mentioned. Such as after passage of time, occurrence of certain events, or performing of assigned tasks.
Departure and dis-ownership: The procedure of dealing with the shares of a leaving co-founder is defined under this clause. It could be stated that the entity will have the preferential right to buy back the shares. In a small group of founders it is not a major concern but it becomes important for the investors.
2.Roles and responsibility: The role of each co-founder must be clearly defined.Decision making for settlement of conflicts Arbitration clause Intellectual property right: The clause states that every IP developed belongs to the company and not the individual creating it.
3.Amendment: The co-founders agreement should not be altered or amended without the consent of all the co-founders. Such consent must be in writing and signed by each and every one of the co-founders. Moreover, this clause should clearly state that without the consent of the co-founders, that too in writing with the signature of all co-founders, none of the clauses in the agreement shall be waived for whatever reason may be. Hence this clause makes it clear that there shall not be any amendment or waiver without the explicit consent by all the co-founders in writing.
4.Non-compete: The clause ensures that founders do not branch out and start their own business and compete with organization.
5.Confidentiality: The clause ensures and imposes obligation on the co-founders to keep sensitive business related matter confidential.
6.Non-solicit: The clause ensures that when founder leaves, he or she should not solicit clients or employees of business to their entities.
These clauses and essentials ensure that the co-founders’ agreement is governed and executed without any or limited risk to the co-founders
Other legal procedures in order to carry out fair business between the co-founders.
Starting a new business is an exciting time in any entrepreneur’s life especially when the co-founders are friends. However, Co-Founders are often so busy building and running their new business that they skip a hugely important step, the Co-founder Agreement. You are a co-founder and would like to clearly set out the equity participation in your new business. This agreement safeguards you in the case of a dispute, as it can provide protection to show what the co-founder agreed too.
A business can be operated without any formal agreement but to prevent the long term risks, it is preferred to follow some legal procedures to carry out fair business between the co-founders.
Article of Association: It is defined under Section 2(5) of the Companies act, 2013. The articles of a company that contains regulations for the management of the company. This document is confined to the applicability of the provisions of the companies act, on private or public limited company, as the case may be.
Memorandum of Association: It is defined under Section 2(56) of the companies act, 2013. The MoA binds the area of operation of the company in respect to the objects mentioned therein and any decision or actions taken in contravention of the MoA shall be void. A company cannot run any business contrary to the main objects mentioned in their MoA. It provides for the limitation on the power of the members and the company. It also deals with both that is affirmative and negative.
LIABILITY CLAUSE: Section 4(1)(D) (i) & (ii) defines the nature of liability of members in case of a dispute.
Effect of AOA and MOA: Members bound to the company, each member is to observe the provisions of the articles and memorandum.
DISPUTE RESOLUTIONIndia has a common law system and therefore, the system is adversarial and offers opposition, so both parties must prove their case.
A co-founder dispute is governed and filled under the civil matter so the standard of proof is on a “preponderance of probabilities” which the greater weight or the probability of the evidence that persuades a judge to lean to one side as opposed to other, during the course of litigation.Generally the main dispute resolution method in India is the court litigation and arbitration.
It is a consensual and effective method of resolving commercial disputes. It allows disputing parties to settle their disputes outside of a national judicial system by referring to a private system of adjudication.
Arbitration agreement is a pre-condition for commencement of arbitral proceedings. An arbitration agreement may be a clause in a contract or a separate agreement to arbitrate all or certain disputes which have arisen or may arise is respect of a defined legal relationship, whether contractual or not.
Every civil or commercial dispute, either contractual or non contractual which can be decided by the court, is arbitrable. However, many contracts do not contain arbitration clause, so the parties must either use court litigation or alternative dispute resolutions such as conciliation, mediation, dispute adjustment board or court-annexed dispute resolution mechanism.
Conciliation is one of the non-binding procedures where an impartial third party, known as the conciliator, assists the parties in a dispute in reaching a mutually agreed settlement of the dispute.
Conciliation is a better dispute resolution when it comes to co-founders’ dispute because:
The conciliator takes the responsibility of getting the disputants to engage in a discussion. Neutrality staves off discussions from assertions and counter-assertions of blame, and guides parties towards solutions that would serve their interests and that of the project. Discussions that the conciliator undertakes separately with each of the disputants enable them to identify measures and solutions to the problems.
Conciliation has the additional benefit of accommodating other concerned parties in the discussions.At the end of these discussions, all the parties aim to arrive at an agreement which will be the basis for the project going forward.
Conciliation is non-binding — there is no compulsion on the parties to settle on terms that they are not happy with or find unworkable.
Importantly, it is also non-binding in that a party can also opt out of conciliation talks, if it finds that resolution is delayed. In fact, it is this voluntary feature of conciliation that makes the process compelling.
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