A founders’ agreement is key in establishing the ground rules of most startups. Such information as founder equity percentages, vesting schedules, duties and responsibilities, handling conflicts of interest, and what happens if someone quits or takes another job outside the company are just some of the many important areas that should be discussed up front and covered in the founders’ agreement.
Founders should also include in their written contract a confidentiality clause, terms on non-competition and non-circumvention, a section on licensing and distribution, a section on founder protection against founder theft of IP, founder resignation or withdrawal procedures, and a clearly defined dispute resolution process.
Founders should also include in their written contract a confidentiality clause, terms on non-competition and non-circumvention, a section on licensing and distribution, a section on founder protection against founder theft of IP, founder resignation or withdrawal procedures, and a clearly defined dispute resolution process.
Startup Founders’ Agreements Can Protect the Idea or Concept
One main use is to protect the startup against one founding partner 'absconding' with the idea or concept and competing with other founding partners, especially if it is not a patentable idea or concept. But even if it is, there is time and expense required to get patents and they can delay the start of a project when timing is crucial to launch before other companies get the same idea and beat the startup to market and gain valuable market share.
Ideally, such agreements should be signed before any other formal agreements like an operating agreement, partnership agreement, joint venture agreement, shareholders’ agreement, or equity vesting agreement have been entered into between the parties. It is also preferable to sign the founders’ agreement before any founder has started working on the product or business idea. A more complicated situation arises in which one founder owns the patent to the idea or concept and the others are there to support the launch of the product through their capital contributions, skills, and expertise. So, in a situation like that, the idea or concept can be protected, but will each of them have an equal right to it even though the patent is only held by one of them?
Ideally, such agreements should be signed before any other formal agreements like an operating agreement, partnership agreement, joint venture agreement, shareholders’ agreement, or equity vesting agreement have been entered into between the parties. It is also preferable to sign the founders’ agreement before any founder has started working on the product or business idea. A more complicated situation arises in which one founder owns the patent to the idea or concept and the others are there to support the launch of the product through their capital contributions, skills, and expertise. So, in a situation like that, the idea or concept can be protected, but will each of them have an equal right to it even though the patent is only held by one of them?
How Will Equity Distribution be Decided?
It is important that a founding agreement address specific details about equity distribution and vesting schedules. For example, equity ownership should be based upon contribution of capital, assets such as equipment, a patent or other types of intellectual property, and work output. The founders’ agreement should also state each person’s obligation to invest in the company and how much time each person would be willing to commit to the start-up before receiving an equity stake. It is important to define what founder obligations are during this initial phase. For instance, founder agreements can state that each founder must give up other jobs or must work full-time to be eligible for founder equity vesting.
As mentioned above, the business idea or concept can easily be protected in a founders’ agreement but how do you determine the equity percentages each person gets? Does the equity vest all at once or over two or three years to make sure everyone is committed to the project? What if one person had the concept and owns the patent, another is putting up 80% of the capital, and a third person has an electrical engineering license to build the prototype? How do the parties determine their relative percentages? This is something that only the founders can decide on after fully discussing the matter with each other and being comfortable with the intrinsic value each of them brings to the table to make the startup a success. Keeping that in mind, the equity percentages are often weighted more heavily in favor of those partners that either hold the patent, a key asset, or have put in the most capital.
The founder equity distribution and founder duties and responsibilities should be stated in the agreement but since founder equity is somewhat subjective, an agreed upon method of valuation of the company is crucial when founder disputes or disagreements arise. Founder equity is sometimes determined based upon how much time each founder has committed to the start-up, as well as capital contributions.
As mentioned above, the business idea or concept can easily be protected in a founders’ agreement but how do you determine the equity percentages each person gets? Does the equity vest all at once or over two or three years to make sure everyone is committed to the project? What if one person had the concept and owns the patent, another is putting up 80% of the capital, and a third person has an electrical engineering license to build the prototype? How do the parties determine their relative percentages? This is something that only the founders can decide on after fully discussing the matter with each other and being comfortable with the intrinsic value each of them brings to the table to make the startup a success. Keeping that in mind, the equity percentages are often weighted more heavily in favor of those partners that either hold the patent, a key asset, or have put in the most capital.
The founder equity distribution and founder duties and responsibilities should be stated in the agreement but since founder equity is somewhat subjective, an agreed upon method of valuation of the company is crucial when founder disputes or disagreements arise. Founder equity is sometimes determined based upon how much time each founder has committed to the start-up, as well as capital contributions.
Can a Founders’ Agreement Require Confidentiality?
Yes, you can put confidentiality agreement terms in a founders’ agreement. You can also have a separate confidentiality agreement between the founding partners or even in the operating agreement, partnership agreement, joint venture agreement, or shareholders agreement (depending on what form of entity is used).
In addition to defining the roles of each party, a good confidentiality section will define (a) the type of "confidential information" that is to be protected, (b) what happens if someone breaches the confidentiality provision, and (c) who can have access to the confidential information. Sometimes employees and independent contractors of the startup company will be required to sign a separate confidentiality agreement as well. Independent contractor confidentiality agreements are highly recommended to protect such things as the company’s customer lists, intellectual property, formulas, marketing strategy, pricing strategy and vendor lists.
Also, I always discuss the following clauses with my clients whether I am drafting a founders’ agreement, operating agreement, partnership agreement, joint venture agreement, or shareholders' agreement:
In addition to defining the roles of each party, a good confidentiality section will define (a) the type of "confidential information" that is to be protected, (b) what happens if someone breaches the confidentiality provision, and (c) who can have access to the confidential information. Sometimes employees and independent contractors of the startup company will be required to sign a separate confidentiality agreement as well. Independent contractor confidentiality agreements are highly recommended to protect such things as the company’s customer lists, intellectual property, formulas, marketing strategy, pricing strategy and vendor lists.
Also, I always discuss the following clauses with my clients whether I am drafting a founders’ agreement, operating agreement, partnership agreement, joint venture agreement, or shareholders' agreement:
- confidentiality clause
- non-circumvention clause
- non-disclosure clause
- non-solicitation clause
- non-competition clause
- hold harmless and indemnity clause
- indemnity and insurance clause
- damages clause/liquidated damages/actual damages
- arbitration vs. litigation clause

Joseph B. LaRocco is a business and corporate attorney that handles business contracts, business transactions, entity formations, and corporate governance.
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What is the Difference between a Founders’ Agreement and an Operating Agreement?
A founders’ agreement will usually be done before a limited liability company operating agreement is entered into by the parties. The operating agreement is what is used for limited liability companies and is similar to a shareholders’ agreement which is used by corporations. The operating agreement is more a matter of corporate governance and good corporate practice, while the founding agreement is more personal to the specific founders. Usually, all founders will be either limited liability company members or shareholders in the company but not all members or shareholders will necessarily be founders. For instance, you could have three founders but ten or more shareholders in a company. If the founders and shareholders are the same however, then you can probably put everything in the shareholders’ agreement.
A Good Founders’ Agreement Enables the Founders to Avoid Needless Disputes
In many situations, it also assists in preventing unnecessary litigation or arbitration. If a matter has been clearly spelled out in a written agreement, partners will think twice about disputing such a matter that was agreed to in writing and which the other partners, if there are more than two, will stand behind in the event one disgruntled partner wants to litigate or arbitrate the matter in dispute.
Similarly, if cofounders cannot agree on key issues such as founder equity distributions and founder duties and responsibilities, a founder agreement can resolve potential disputes. Founder disputes are most likely to arise when a founder's equity is not yet vested, or a founder is incapable of or decides not to deliver what was promised in their written agreement.
A founder agreement will prevent someone from leaving with a valuable asset or taking company owned assets without paying the agreed upon compensation to the company. Similarly, the terms of the founding agreement will control what happens when a founder wants to sell or there is a dispute over valuation of equity or other assets of the company.
Saving money and drafting such an agreement without the assistance of a competent business attorney is, as the saying goes, penny wise and pound foolish. Spend the time and money to avoid problems down the line, which can easily end up costing more than what would be spent to pay an experienced startup attorney to draft a strong founders’ agreement.
A small business with two partners opening restaurant or dry cleaners my seem simple enough, but believe me, there are numerous issues to be covered. At the same time, a two person founders’ agreement for a restaurant or dry cleaners will typically be much easier and less costly for an attorney to handle than a tech startup with three or four partners, a patent, and outside investors. So don’t cut corners on a legal document for a valuable asset (a business that could someday be worth $1,000,000 or more). The repercussions of that document will be far reaching for many years, so it pays to do it right and make sure all the bases are covered and the partners are in agreement.
Similarly, if cofounders cannot agree on key issues such as founder equity distributions and founder duties and responsibilities, a founder agreement can resolve potential disputes. Founder disputes are most likely to arise when a founder's equity is not yet vested, or a founder is incapable of or decides not to deliver what was promised in their written agreement.
A founder agreement will prevent someone from leaving with a valuable asset or taking company owned assets without paying the agreed upon compensation to the company. Similarly, the terms of the founding agreement will control what happens when a founder wants to sell or there is a dispute over valuation of equity or other assets of the company.
Saving money and drafting such an agreement without the assistance of a competent business attorney is, as the saying goes, penny wise and pound foolish. Spend the time and money to avoid problems down the line, which can easily end up costing more than what would be spent to pay an experienced startup attorney to draft a strong founders’ agreement.
A small business with two partners opening restaurant or dry cleaners my seem simple enough, but believe me, there are numerous issues to be covered. At the same time, a two person founders’ agreement for a restaurant or dry cleaners will typically be much easier and less costly for an attorney to handle than a tech startup with three or four partners, a patent, and outside investors. So don’t cut corners on a legal document for a valuable asset (a business that could someday be worth $1,000,000 or more). The repercussions of that document will be far reaching for many years, so it pays to do it right and make sure all the bases are covered and the partners are in agreement.
Non-Competition
It is a good idea to spell the terms out of what the founders can and cannot do in terms of competing with the company. If the agreement is silent on non-competition, most state laws require “fiduciary duties” between the founders anyway, which would prevent side deals and circumventing the other founders. That means any transaction or deal that could be done by the company owned by the founding partners, must be offered to the company first. Every contract also has implied covenants of good faith and fair dealing, so the business partners need to treat each other fairly and that includes anything that could affect the mutual interests of the business partners.
Right of First Refusal, Exiting Founder, and Buyout Terms
A good agreement between founders will enable one founding owner to purchase the interest of an exiting founder at an agreed upon price. The agreement should spell out under what situations one partner may sell to another, such as health complications, sale after a fixed number of years, sale after certain milestones have been met, or a default (as defined in the agreement) by one founder. There should always be a right of first refusal given to the other founders, but that’s where it gets tricky.
The Agreement Between Founders Should Answer a Number of Questions Like:
- At what price should the right of first refusal be, especially if a third-party makes an offer?
- Does the company get the right of first refusal or just the other founders on a pro rata basis?
- Does the price have to be paid lump sum or can it be paid over a few years with interest?
Some clauses I have drafted provide that either the founders agree on a price every six months or when the time comes a business appraiser or valuator is hired. Sometimes three appraisers will be required, and an average price taken, or the high and low valuations get thrown out and the middle valuation is used.
A contentious situation arises when founders discuss their rights to sell their equity interest. Not all founders will have the same ideas when it comes to an exit strategy. Some of the founding partners may want to go public, while others may want to sell out as soon as they can realize a certain sale price or achieve a certain milestone in gross profits or net profits. Others may not want to sell for twenty-years and have hopes of passing on their ownership interest, and maybe even employment, to their son or daughter.
The agreement should also provide for what happens if one of the founders dies. Usually, the company gets first right to purchase from the deceased founder’s estate and then if the company waives its right to purchase, the remaining founders can purchase pro rata. Again, the agreement should clearly spell out pricing, interest, and over what period of time the buyout must be paid.
A contentious situation arises when founders discuss their rights to sell their equity interest. Not all founders will have the same ideas when it comes to an exit strategy. Some of the founding partners may want to go public, while others may want to sell out as soon as they can realize a certain sale price or achieve a certain milestone in gross profits or net profits. Others may not want to sell for twenty-years and have hopes of passing on their ownership interest, and maybe even employment, to their son or daughter.
The agreement should also provide for what happens if one of the founders dies. Usually, the company gets first right to purchase from the deceased founder’s estate and then if the company waives its right to purchase, the remaining founders can purchase pro rata. Again, the agreement should clearly spell out pricing, interest, and over what period of time the buyout must be paid.
What are Dissociating Founders?
When a founder quits or for one reason or another is no longer part of the company, the founders’ agreement should define what happens in that situation. First of all, the agreement should define what is meant by a “dissociating founder” or “dissociation”. This is important because the buyout provisions of a dissociating founder may be less favorable if the dissociation is because of that person’s intentional refusal to carry on their required duties, as opposed to a founder that falls ill and must retire. The dissociation provisions will also dictate how ownership is to be transferred among remaining founders if the company does not exercise the buyout of that person’s equity interest.
Another advantage is that it can assist in resolving inventor disputes over ownership rights, royalty sharing and assignment among founders. The agreement should detail each founder's duties and responsibilities to the start-up such as the required minimum number of hours each founder must work per week to prevent a founder from shirking their duties and responsibilities. It should also make clear what happens if a founder’s duties and responsibilities are not being met.
Some of the major benefits of a founders’ agreement are to define founder equity and establish a founder vesting schedule thus protecting the start-up against founder ownership and equity disputes. Founder agreements should also provide for a fair valuation process. Another benefit is that it should clearly state each founder's obligations and will prevent founder from founder embezzlement or founder theft of IP. When the start-up is developed, the agreement should define how founder equity disputes will be resolved. Mediation and arbitration of founder disputes is the preferred method, instead of resorting to expensive and lengthy litigation.
Another advantage is that it can assist in resolving inventor disputes over ownership rights, royalty sharing and assignment among founders. The agreement should detail each founder's duties and responsibilities to the start-up such as the required minimum number of hours each founder must work per week to prevent a founder from shirking their duties and responsibilities. It should also make clear what happens if a founder’s duties and responsibilities are not being met.
Some of the major benefits of a founders’ agreement are to define founder equity and establish a founder vesting schedule thus protecting the start-up against founder ownership and equity disputes. Founder agreements should also provide for a fair valuation process. Another benefit is that it should clearly state each founder's obligations and will prevent founder from founder embezzlement or founder theft of IP. When the start-up is developed, the agreement should define how founder equity disputes will be resolved. Mediation and arbitration of founder disputes is the preferred method, instead of resorting to expensive and lengthy litigation.
Summary
In summary, a founders’ agreement protects the startup by addressing founder disputes pertaining to founder equity distribution, founder duties and responsibilities and providing a mediation or arbitration process to resolve those disputes quickly and inexpensively without resorting to litigation. Although an issue of founders' rights would normally be covered under business incorporation statutes, the agreement should be designed as an addendum to the founder's operating agreement or shareholders’ agreement depending on the corporate structure that is used by the parties.