Legal Agreements : Founder and Shareholders

What is Founder’s agreement?

The founder’s agreement is the mutual agreement entered into by the founder and the co-founder(s) of a company, partnership firm or limited liability partnership (LLP).

The founder’s agreement

t is very similar to the shareholders’ agreement, as it specifies the amount of investment and the percentage of ownership the founder and co-founder(s) have to the company.

Hence, in the form of shares or equity, the ownership vested on the co-founders are recorded on a stamp paper in the form of an agreement.

What are the benefits of making a founder’s agreement?

There is no compulsion of making a founder’s agreement, nor notarization is mandatory, but a founder’s agreement removes several complications and disputes in the operational work, as well as the company’s goodwill in long run.

The main utilities of a founder’s agreement are as follows:

  • Remedy to the issues before it arises: As the main feature of the founder’s agreement is to determine the role and responsibilities, shareholder structure, control/corporate governance, lock-in period, hire/fire/retire, transferable of shares, other provisions, there is always a clarity to the allocation of each co-founder. This reduces confusion and later the co-founders can have a clear demarcation of their rights and liabilities.
  • Non-problematic exit of co-founder: A co-founder is an important person to a startup, the investors mainly trust the co-founders at the time of seed funding, as the investment is into the idea and the trust built by the co-founders. Therefore, if one of the co-founders exit the company, several matters require to be revised. In presence of a founder’s agreement already giving clarity of the position and power of the co-founder, the exit settlement and handover of the rights and liabilities become much easier and smooth.
  • Intellectual Property: Intellectual Property invests a right to the owner, and the IP rights relevant to the trademark and copyright affecting the business requires to stay in the hands of such a person who works towards the benefit of the startup.

If the founder’s agreement has a clear understanding of the ownership and the extent of ownership of the intellectual property, there is less likely to arise confusion.

  • Confidentiality and Non-Competition Clause: An idea is the soul of a startup, however, an idea can not be copyrighted, unless it is converted into a tangible form. Therefore, it becomes utter necessary that the co-founders get abided by the terms of confidentiality and non-competitive. In case a co-founder changes his mind to be a competition, the startup, and its idea can be safeguarded.

If the idea of the soul of a startup, then its data forms the backbone of the startup. Hence, the data protection imposed by the founder’s agreement plays a severe role in the security of the goodwill and position of the startup in the market.

  • Decision Making and Dispute Resolution: The co-founders may have different opinions at any point in time. If a well-executed founder’s agreement exists, the sphere of the individual co-founder can be easily identified and it becomes easier to decide, who should be the person making the final decision in the concerned matter.

In case, the disagreement extends itself to a dispute, the founder’s agreement can come to the rescue. A founder’s agreement must specify the dispute resolution mode and power. Therefore, before there is a dispute, it will be obvious where the matter is to be taken for a resolution.

The founder’s agreement may also invest a right to terminate a co-founder under certain terms and conditions.

How to prepare a founder’s agreement?

To draft the founder’s agreement for your startup, LexStart has a team dedicated to providing support, who will furnish you with all the required assistance from starting to running a business. 

The team of lawyers and company secretaries shall help you to steer through the regulatory and legal compliance you would require for carrying on

 your business.

What is a shareholder’s agreement?

The shareholder agreement helps protect the interests of current shareholders from cases of abuse by future management. If there is new management or the company is acquired by another entity, the agreement helps safeguard certain decisions such as dividend distribution and issuing of new stock or debt.

Some of the issues covered in the shareholder agreement include dealing with shareholders’ issues, corporate distributions, the management team of the company and limitation on authority, rights of minority shareholders, valuation of shares, voting of shares of stock, restrictions on the transfer of shares, allotment of additional shares, etc. The agreement protects shareholders, and it can be used as a reference document if there are disputes in the future.

What are the important clauses of a shareholder’s agreement?

The contents of a shareholder agreement may vary across companies. Some of the contents of a shareholder agreement include:

1. Parties

The first section of a shareholder agreement identifies the corporation as one party that is different from the shareholders (another party).

2. Board of Directors and Board meetings

The shareholder agreement describes the role of the board of directors in the company and the requirement that decisions of the board should be approved by the majority. It also states how frequently the board of directors should hold meetings and how directors are selected and replaced.

3. Reserved Matters

The shareholder agreement should set out issues that cannot be passed without getting the approval of all signatories, not just majority support. By creating a list of reserved matters, all shareholders are given the chance to vet certain transactions to determine if they are prejudicial to their investment.

Some of the commonly reserved matters include changing share capital, acquiring or disposing of certain assets, taking on new debt, paying dividends, and changing the articles of association and memorandum.

4. Shareholder Information and Meetings

The shareholder agreement should include a requirement that shareholders are entitled to regular updates on the company’s performance through quarterly reports and annual reports. It should state the specific period when the reports should be sent out to shareholders. The agreement should also state when shareholder meetings will be held and the time, date, and venue of the meetings.

5. Share Capital and Share Transfers

The shareholder agreement should record the corporation’s share capital at the date when it is signed. Since changing share capital is one of the reserved matters, the directors are prohibited from issuing new shares or changing existing shares into a new share class without the signatories approving the changes.

The shareholder agreement also contains provisions relating to share transfer, such as preventing share transfer to unwanted parties, transferring shares to a new party, what happens if a director or shareholder dies, as well as drag and tag provisions.

6. Amendment and Termination

The process of amending or terminating the shareholder agreement should be provided in the agreement. For example, the shareholder agreement may be terminated upon the dissolution of the company, based on a written agreement, or after the lapse of a specific number of years from the date of the agreement.

How Shareholder Agreements Protect Minority Shareholders?

Minority shareholders lack voting control of the company, and in the absence of a shareholder agreement, these shareholders will exert minimal influence in the running of the company. Key management decisions can be made by the few controlling shareholders who own more than 50% of the company, and they may not consider input from the minority shareholders.

Even if the articles of association protect the minority owners, the provisions can often be altered through special resolutions approved by the majority shareholders. The shareholder agreement may address these loopholes by requiring that key company decisions be approved by all shareholders regardless of their voting power.

Such rules limit the ability of the majority shareholders to overrule minority shareholders when making certain decisions, such as the issue of new shares, taking new debts, and the appointment and removal of directors, etc.

How Shareholder Agreements Protect Majority Shareholders?

Apart from protecting the minority shareholders, the shareholder agreement may also protect the majority shareholders where minority shareholders are uncooperative. For example, majority shareholders may require the inclusion of a drag-along provision that allows them to sell part or all of the shares at a specific time and price even if the minority shareholders are unwilling to agree on the transaction.

Also, the shareholder agreement may include a clause that prevents minority shareholders from transferring their shares to a competitor or other party that majority shareholders do not want to get involved in the company. The agreement should also define rules on the sale and transfer of shares, who can purchase shares, the terms and prices, etc.

What is the importance of having a shareholder’s agreement?

Apart from protecting the minority shareholders, the shareholder agreement may also protect the majority shareholders where minority shareholders are uncooperative. For example, majority shareholders may require the inclusion of a drag-along provision that allows them to sell part or all of the shares at a specific time and price even if the minority shareholders are unwilling to agree on the transaction.

Also, the shareholder agreement may include a clause that prevents minority shareholders from transferring their shares to a competitor or other party that majority shareholders do not want to get involved in the company. The agreement should also define rules on the sale and transfer of shares, who can purchase shares, the terms and prices, etc.

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