Usually, the articles of incorporation and company by-laws are not sufficient to protect the interests and expectations of each founding shareholder in a start-up. Even before outside investors come on board, many start-ups enter a shareholder agreement to protect those interests and expectations.
It is important for founders to understand that shareholder agreements entered between two co-founders serve a different purpose than a shareholder agreement entered when private accredited or venture capital investors are involved. Smart founders have a defined relationship in place with co-founders, employees, contractors and option holders before they approach investors. Doing so will illustrate they are serious in protecting their (and the company’s) interests, even if that agreement needs to be renegotiated, supplemented or amended to suit the demands of subsequent investors.
Without a shareholder agreement the control and operation of a start-up is fairly rudimentary. In most instances the majority rules. That means, the majority shareholder (holding voting shares) can appoint the directors of the company and in-turn control the management of the company with little input from the minority shareholders.
For example, if two individuals started a company with one owning 51% and the other 49%, without a shareholder agreement, the majority shareholder would be entitled to appoint the entire board of directors. For a minority co-founder who is investing significant time, skill, expertise or money, this is a concern. For this reason, some co-founder agreements include provisions in which all shareholders agree to vote both co-founders into office, at each annual general meeting of the shareholders, so long as each founder remains a shareholder.
In that case, it is sometimes minority shareholders who stand to benefit more from entering a shareholder agreement. However, the clarity that arises from entering the agreement can also serve to benefit a majority shareholder and the company itself.
Unfortunately, because most start-ups cannot afford to pay a lawyer to tailor their agreements for them, they either fail to enter a shareholder agreement, or they adopt a boilerplate agreement that has counterproductive terms and conditions, or terms the parties didn’t understand the full meaning and impact of.
Negotiating Founder Agreements
While it is easy to think founder agreements are simply a matter of dividing up equity and capital investments, the reality is that founder agreements should deal with a lot more.
The rights distributed in a founder agreement can be far more complex and important than most founders realize. This section is intended to help you understand what issues you should be thinking about (and negotiating on) to form your founder agreement.
Once you read this section, consider using a form of non-binding founder term sheet for sketching out the general terms of your agreement. Doing so will make it easier for your lawyer (and hopefully less expensive for you) during the drafting process.
Without a summary of the core terms you’ve agreed to with your co-founder, usually a lawyer for one founder drafts a generic agreement and the parties spend days, weeks and even months trying to agree on amendments and understanding the terms.
Important Issues to Negotiate
Aside from the actual division of equity, in my opinion, the most important issues to discuss and try to document are:
- Control of the board of directors and who has a right to sit on the board or nominate board members;
- How founder shares are issued (i.e. on a vesting schedule or not);
- How shares can be issued to new shareholders;
- How founder loans can be incurred by the company and repaid;
- Whether any security interests (for example granting security to one founder over the company’s assets, inventory, intellectual property etc.) will be granted to secure the founder’s loans to the company;
- Who can incur and repay expenses on behalf of the company (and in what amounts);
- Who will have contract signing and spending authority;
- Whether the founders are working full-time, and what other business interests they have (or will be permitted to have in the future);
- Who will be entitled to compensation and when (whether in the form of employment income, consulting fees or dividends);
- The assignment of intellectual property rights;
- Who will have access to information about the company (including financial information, bank account access, accounting software access etc.). Some companies may consider other types of account access, for example, who will have access to software code repositories like GitHub, or payment processing accounts like Stripe, PayPal etc., email accounts, domain accounts, social media accounts, etc.;
- Whether there will be restrictions on founders competing with the company or soliciting contractors, staff or customers of the company in the context of their other businesses; and
- How the co-founder relationship can or will end. For example, will there be events that can lead to the forced sale of one party’s shares (vesting terms, shotgun clauses or trigger events like death, disability, divorce, incarceration, bankruptcy, the resignation of a founder etc.). More on this below.
Of course, there are other issues founders can cover-off in their agreements. From the workings of employee option plans to drag and tag along rights in the event a third party wants to acquire the company, but let’s get to those later.
A Fair Agreement
Clients often come to me and say, make the agreement fair. But what is fair in different circumstances varies, as do opinions on what constitutes ‘fair’. How the above issues are addressed, and what constitutes ‘fair’ in a co-founder agreement may be impacted by factors like:
- Whether one or more of the co-founders is contributing a large cash investment or loans to the company;
- Whether one or more of the co-founders is bringing, or will be creating intellectual property (like software code, designs, trademarks/brands etc.);
- Whether one or more co-founder is only working part-time on the start-up;
- Whether one founder previously worked on developing the business or its product prior to the involvement of the second co-founder;
- Whether the relationship will result in a 50–50 split or a majority-minority shareholder position; and
- Whether there will be more than two co-founders.
The 50–50 Relationship
Often the hardest relationship to document is the 50–50 start-up, where both founders are to hold, initially, 50% of the shares and be one of two board members. The reason this can be the most difficult relationship to document is simple, it can lead to deadlock, where no single person is in control.
Sometimes, the fairest option is to require both founders to consent to all major decisions. However, the 50–50 relationship can lead to paralysis, where no decisions can be made, especially in the event of a founder dispute.
While there are provisions of a founder agreement you can include to address 50–50 deadlock, they often do not sound appealing to either founder. This is because they present the risk of losing what control each founder does have, to block or veto decisions on the board of directors.
That said, the main provisions to consider in addressing 50–50 deadlock, are:
- Vesting shares (if one founder’s shares do not fully vest, it may result in a majority-minority shareholder relationship) potentially breaking the deadlock;
- The appointment of one of the two founders as a chairperson, with a deciding vote on all or select issues. For example, one founder could have a deciding vote to break ties on hiring or firing staff, taking on debt, signing a new contract, raising money, etc.
- The appointment of a third board member (even though ownership is still split 50–50) who has the ability to make tie breaking decisions; and
- A shotgun clause (which can be used to ensure the end of a co-founder relationship).
The Shotgun Clause
Each provision to break deadlock or founder disputes has its own risks, which you should discuss with your lawyer to ensure you understand. Whether you decide to implement the ability to break potential deadlock should be considered in your own circumstances, with your own lawyer.
The shotgun clause, in particular, should be carefully considered before being included in your agreement. A shotgun clause permits any shareholder to offer to purchase another shareholder’s shares. If the offer to purchase is declined, the other shareholder is required to purchase the offeror’s shares, on the same terms. It is an extreme remedy for owner disputes, which some lawyers refer to as the nuclear option, because it ensures a means to breakup two or more founders.
While it can ensure a breakup of the co-founder relationship, the main risk of a shotgun clause is the forced exit from a company you may want to remain with, or on terms you may not necessarily agree are fair. The shotgun clause can be abused, and in some circumstances, be regarded as unfair. For example:
- In early-stage start-ups where the company’s fair market value is difficult to ascertain, or where only one of the founders has the technical ability to operate the business;
- One founder has fewer financial resources than the other, meaning they could never be a buyer in the shotgun scenario;
- If one founder is older or otherwise clearly has no desire to be a buyer. That is, they clearly do not want to continue to operate the company without their co-founder;
- If either founder has outstanding personal guarantees related to the company’s debts, which they can’t get out of even upon exiting the business;
- It may be difficult for one founder to determine if they should be a buyer if they don’t have equal access to information, including updated financial information about the company, sales prospects, new customer relationships, etc.; and
- One founder may not have the support from necessary employees or customers, if the other founder were to leave.
More importantly, when combined with the assignment of a founder’s IP, non-compete and non-solicit obligations, a founder could be forced to leave and not be permitted to start a competing operation or make a living in the same industry.
That said, a shotgun clause may make a lot of sense in a traditional business, that has fixed and hard assets on a balance sheet, on-going revenue and sales, and shareholders of comparable financial resources.
Control of the Board and Management of the Company
The issue of control can be complex.
Without a co-founder or shareholder agreement, one or more voting shareholders who form a majority can control the company by voting in and out the company’s board of directors.
This means they control the corporation and its management. Unless there is an agreement that says otherwise, those management rights include the ability to issue new shares (which might dilute existing founders), bring on new shareholders, enter contracts, control spending and bank account access, take on loans, hire and fire staff, appoint officers (President, CEO, Chief Technology Officer etc.) and many more.
While some founders are fine with a majority holder exercising complete control, some are not. A founder agreement can balance the control issue by specifying how decisions on important issues can be made, and in what scenarios the approval of more than a simple majority of the board is required to make a decision.
In terms of issues around control and management to negotiate with your co-founder, here is a list of some of the most important ones:
- Will each founder be entitled to sit on the board of directors, regardless of whether they hold a majority of the shares?;
- How are new board members approved or elected? Is it a simple majority vote of the shareholders, or will founders have the right to nominate and appoint a certain number of directors?;
- If there are only two founders, are you accepting that a 50–50 board may lead to deadlock, or do you want to have a means of breaking potential deadlock?;
- If you want a means to break potential deadlock, how do you want to do it? See some of the options above;
- Are there any issues or decisions the company makes that the founders want to have a veto on, or a different threshold (aside from a majority vote)? For example:
- Issuing new shares, which will dilute the founders;
- Selling all or a material company asset (like its main software product);
- Taking on new loans or debts;
- Allowing existing shareholders to sell or transfer their shares;
- Expenses above a certain dollar amount;
- Hiring new staff or contractors or paying founders a salary;
- Paying dividends on shares;
- Amending the company’s articles of incorporation;
- Dissolving the company or entering a merger;
- Commencing litigation; or
- Others, unique to your company’s circumstances.
The Appointment of the Board
As mentioned, without a founder agreement or other form of agreement among shareholders, the board of the company is voted in by a majority of the voting shareholders, in accordance with the company’s articles of incorporation and by-laws.
This means, if two directors are appointed when the company was formed, and there are only two shareholders with equal equity and voting rights, the addition or removal of any board member would require the consent of both shareholders.
However, if there is a division of equity that is anything other than 50–50, any founder or group of founders who can form a majority, can vote in and out the board. This can be problematic if you are a minority shareholder or a founder with an expectation that you will continually be allowed to remain on the board of the company with management and information rights.
The Right to Continually be Appointed to the Board
As a result, founders, even those in a minority situation, can negotiate as part of the founder agreement, for the right to have all shareholders vote to appoint them (or their nominee i.e. someone who will look out for their interests) to the board, irrespective of the fact that they do not, themselves, have enough shares to carry a vote.
While being a board member, or the right to appoint a board member, can be an important right to have, being a board member is a serious undertaking. It presents its own risks and liabilities and requires you to make sure you are acting in the best interest of the company, kept apprised of the company’s finances, material contracts and have a good understanding of what the company is doing, among other obligations. As we explored earlier, individual liability, as a director, can be imposed on you for things like unpaid corporate taxes, unpaid employee wages, environmental damages and others.
For this reason, and others, some minority shareholders prefer not to sit on the board, but retain contractual rights that give them some of the powers they may have had as a board member. While that may be preferable, for various reasons, there are scenarios where doing so, even as a shareholder, can impose some of the same liabilities on you as if you were a director.
Issuing New Shares
One of the most important tasks the board of directors has is issuing additional shares.
While there are different routes you can go, at a minimum, you want to make sure that no additional shares can be issued without a duly passed board resolution. Some companies elect to go even further and require that the board must have the unanimous consent of all board members or the consent of all founders or shareholders, to issue new shares. This leaves even minority founders in a position to veto the issuance of new shares, which would have the impact of diluting their shareholdings.
The more common right founders often include is a right of first refusal. If the board agrees to issue additional shares, the right of first refusal gives each founder the ability to purchase whatever portion of the new share issuance required for them to maintain their then current equity percentage. For example, if you own 25% of the company, and the company is selling $100 worth of new shares, you can contribute $25 and maintain your 25% shareholding.
The issue here, for early-stage companies, is often young first-time founders are not flush with cash to pony up in the event major capital is being raised. So even with a right of first refusal on the issuance of new shares, they may not be in a financial position to do so. For those types of founders, they may want to hold on to a veto right. They could do this by requiring a unanimous decision to issue new shares, at least in the early stages, so they have a degree of control over new shareholders coming on board that they may not want involved in the company, or that may dilute their ownership in a way, or to an extent, they don’t agree with.
Keep in mind, this right, can sit in the founder agreement until such time as investors (injecting real cash) come on-board, and the group of new shareholders (founders included) can agree on a new form of shareholder agreement removing a founder’s veto rights and re-addressing how the issuance of shares will be governed.
Dealing with Founder Loans and Expenses
Some founders like making it clear that while neither founder will be obligated to advance loans or cover company expenses, to the extent they do so, the company will document all the loans and expenses and repay them when the board determines there is sufficient capital to do so.
Likewise, it often makes sense to agree that no founder loan will be repaid in priority to any other founder. That is, founder loans are only repaid proportionally to the value of their loans at the time of the repayment. For example, if founder A lent $70,000 and founder B lent $30,000, when the company wants to repay $1,000 worth of loans, it has to repay $700 to founder A and $300 to founder B.
It is sometimes desirable to require unanimous consent from each founder to repay all or any portion of a founder’s loan. This helps protect the company, as it means that neither founder can demand repayment in a manner that might cause the company to become insolvent. On the other hand, as a founder you are agreeing that you may not get your loan back until the company is well capitalized.
Although it is up to the founders to decide what they view as being fair and reasonable, in some cases, founders register security interests over the assets of the company (for example, IP, inventory and other assets) as collateral for their loans. This is rare in early-stage companies, as it means future investors or other co-founders may reject the notion that one founder has security over their investment while they do not. That said, it certainly may form part of the agreement, especially where one founder intends on becoming much more indebted than others.
It a fast-moving start-up, it’s not uncommon for some or all of the founders to have incurred expenses to get things going, whether buying a domain name, paying a developer for some initial code, paying for AWS accounts, bank fees, incorporation fees, legal work, you name it. Often the company is not in a financial position to immediately repay expenses. In these situations, a founder agreement can specify that, if the company approves of the expense, it will add the expense amount to the applicable founder’s loan account and record it as an amount owing to the founder.
Intellectual Property Ownership
Often prior to incorporating a company one or more of the founders has created intellectual property, whether software code, algorithms, designs, logos, or other forms of intellectual property.
In most cases, the founders agree that any intellectual property they each develop (or previously developed) in the context of the company’s operations, or which is brought to the company for it to use, will be owned by and assigned to the company, or, at a minimum, will be licensed to the company for it to continue to use.
While there are exceptions, the general starting point is that the creator of the intellectual property (whether copyright, trademarks, or patentable works) owns it. This may not be the case if the works were developed under an employment relationship or under an agreement that expressly says otherwise.
Each founder should be careful to ensure that any intellectual property they developed, while under an employment relationship (even if they terminated that relationship before starting their new company) is not owned by their previous employer or other third-party.
It is a good idea to have your lawyer review any previous or current employment agreements or relationships you entered which may have an impact on the ownership of intellectual property you intend to bring to your new start-up.
Likewise, this makes (i) documenting the ownership of your works which you previously developed and are bringing to the company for it to own or use; along with (ii) negotiating the future assignment of your new works, an important component of the founder agreement.
Without documenting the assignment or licensing of a founder’s intellectual property, there is a risk that should he or she depart the company, the company may be left with no legal right to continue to use the intellectual property.
While it may seem obvious to want to have each founder assign all intellectual property they create in the context of the company, for it to continue to use, there are individual circumstances that may lead to a founder not wanting to do so. Take for example the scenario where a founder develops a general algorithm, that may be applied in various industries or for various purposes. It may be that the founder only wants the start-up to have a right to use the algorithm for a specific purpose, but not to allow the company to actually own the algorithm outright. In those cases, looking at licensing agreements may make more sense.
Domain Names
Similar to intellectual property, intangible property like domain names are sometimes acquired by an individual founder, in their own name, prior to incorporating. To ensure the company can continue to use the domain names you may want to assign them, in the founder agreement, to the company.
For example, the founders could agree that upon executing the founder agreement, any founder who owns domain names the company will use, will transfer them to a domain registrar account operated in the name of the company. The transfer price could be at the price the founder originally paid to acquire the domain name, or some other agreed upon value.
You might think the domain name issue isn’t an important one to address. However, often a company’s website and social media accounts can form the primary means of driving business. If one founder were to leave the company and take the position that they own the domain names, it could have serious consequences for the company and its ongoing operations. The same applies to other accounts, such as GitHub accounts, social media accounts, access to email accounts etc.
Non-Compete
It is not uncommon for some founders to have an interest in multiple businesses. For example, founders who have a track record of building various app or software programs may want to continue to have the right to be a shareholder and/or director of other companies, even ones in a similar space.
That said, the company itself and future investors, should or will want some assurance that founders won’t leave and start a competing business.
What is often up for negotiation between founders is the scope of the non-compete. It can take thoughtful drafting to narrow down what the company wants to legitimately protect. This can only be done in the context of what the business does (or intends to do) and what the individual founders want to ensure they can continue to do in the future, regardless of what happens with their new start-up.
That said, assuming you want to include a non-compete, the two main factors to negotiate are (i) how long the non-compete will last after you cease to be a shareholder; and (ii) what, specifically, it precludes you from doing.
Overly broad non-compete clauses (both in duration and what it precludes you from doing) risk being found to be unenforceable, as courts generally do not like seeing people contract out of their ability to make a living. For example, if you are a graphic designer, it wouldn’t be a good idea to contract out of your right to provide graphic design services after you leave your start-up.
On the flip side, if you are a software developer, you may reasonably contract out of your right to work for another enterprise building an application or software that directly tries to compete with the same software your start-up was developing.
Founders and their lawyers should consider the specific scope of the non-compete in their own personal circumstances and the circumstances of the company.
Director Duties in the Conflict of Interest and Non-Compete Setting
Individual founders should also consider, and seek advice on their duties as directors of the company (assuming they are acting as a director). Even without a non-compete clause in the founder agreement, founders can have statutory restrictions on what they can and cannot do outside the context of the company.
For example, directors have a duty to avoid conflicts of interest, which, in some situations, may operate similar in nature to not having interests in competing companies, or an interest in transactions which are conflicting in interest with the company.
Directors may also have statutory and common law duties not to divert corporate opportunities they become aware of, which, in ordinary circumstances, the company may want to pursue.
So, even without a non-compete clause, a director may be in breach of their duties to the company if they were to learn of an opportunity that their company would want to pursue, but assign that opportunity to another business with which the director is involved in, or has an interest in. Directors in these circumstances may have to disclose the opportunity and refrain from voting or participating in the decision-making process on whether or how to pursue it.
Non-Solicitation
What is often far more important, and likely has a better chance at being enforceable by courts, are restrictions on founders being able to solicit the staff, contractors and customers of the start-up.
It is often agreeable between the founders that they won’t leave the business and take employees, contractors and customers with them. Just like with a non-compete, this also provides good signals to future investors.
That said, there are scenarios where founders do not agree to non-solicitation clauses. For example, a founder may be using a specific software developer to provide services to the start-up and simultaneously be using the same person for one or more of their other businesses. Again, for that reason, the non-solicitation clause has to be considered in the individual circumstances of what your start-up does, and the personal circumstances of each founder.
Confidentiality
For start-ups, protecting designs, trade secrets, software code, product research and development, customer lists and other forms of confidential information can be important for ensuring competitors don’t get the upper hand.
The founders agreeing to keep non-public information about the business confidential until such time as it is reasonably necessary to advance the company’s interests (or required by law) to disclose it, often makes sense and is generally not a contentious part of any founder agreement.
Founders should equally consider what other confidentiality obligations they have with third parties, and take steps to ensure they are not in breach of those obligations in the context of their new business. The most common scenario where this becomes a risk is where you have access to confidential information owned by a previous employer.
Vesting Provisions
Particularly in start-ups where neither founder is making a large cash investment, it is common for one or more of them to be on a vesting schedule. That is, their shares are either dripped to them over a period of time, or the opposite, they acquire their shares up front, but the corporation or another founder has the right to repurchase all or a portion of those shares if they were to leave.
The actual mechanics of a vesting relationship vary quite significantly. Vesting provisions can be in your founder agreement or in a separate stock option agreement. Some lawyers also include them in the form of a restricted stock subscription agreement or ‘RSA’.
Wherever they reside, the most important factors are:
- How long is the vesting schedule. It is common to see anything from 1–4 years;
- How frequently the shares vest (i.e. monthly, quarterly, yearly etc.);
- What constitutes a trigger event giving rise to the shares no longer vesting. For example, does the founder have to formally resign and leave, can he or she be fired from the company, etc.
RSA’s and Reverse Vesting
Reverse vesting is the concept that a founder will acquire all of his or her shares upfront, but the company will have an option to buy them back in the event the shares do not fully vest, whether based on a timeline or milestones.
This protects against the scenario where one founder quits (especially where they were issued shares for nominal value) and the other founders continue to operate the company. In that situation the company will not want to find itself in the situation where one shareholder is doing no work, has left the company but enjoys the profits of the company as if he remained, for example, a 50% shareholder.
Reverse vesting of course can become more complex where a founder has actually contributed something of value to the corporation in exchange for their shares. For example, if co-founder 1 brings intellectual property, software code etc. to the company, and is assigned shares in consideration for transferring the right to the software code, it would likely impact the terms of any vesting agreement.
The same is true, of course, where one of the founders is actually investing substantial sums of cash into the business to acquire his or her shares.
How you manage the vesting of shares may be impacted by important tax considerations. You should always speak with a tax advisor before agreeing to vesting and reverse vesting provisions or the acquisition of any securities (stock, options, convertible debt etc.) for that matter.
Mandatory Share Sales
Aside from a founder agreeing to have their shares vest (or reverse vest) to them over a period of time, there are events that may occur which the founders may want to agree, up front, will trigger a right or an obligation for them to sell their shares. While this may include the resignation or termination of a founder’s involvement with the company, the most common events (often referred to as ‘trigger events’) are:
- Death;
- Disability;
- Divorce; and
- Bankruptcy.
The result of these events is that a remaining founder will not have the benefit of their co-founder continuing to be actively involved in the company, or worse, a third party may actually, by operation of law, take control of a founder’s shares. For example:
- In the event of death, an estate may take ownership of the shares;
- In the event of disability, the co-founder may no longer be able to contribute to the company;
- In the event of divorce, as part of the family law proceedings, a spouse may obtain a court order for the transfer of shares as part of dividing up the net family property;
- In the event of their bankruptcy, a co-founder may be required to transfer their shares in your company to a creditor.
When founders, especially of an early-stage company, enter a business relationship with a co-founder, they likely do not want to be left in a scenario where their co-founders shares are transferred to a new shareholder, or no longer be able to benefit from the work of their co-founder. In these cases, it often makes sense for co-founders to agree that they will (if asked to do so) sell their shares back to the company, or to their co-founder, at fair market value.
Other trigger events to consider include:
- The resignation of a founder, even after their shares have fully vested;
- The termination of a founder’s role with the company (whether as a director, officer, employee, contractor etc.); and
- The incarceration of, or one founder being convicted of a crime in relation to the business, like fraud.
How fair market value is determined is any entirely separate matter, but it is often whatever price the parties can agree to, and if it cannot be agreed upon, your founder agreement can require a valuation process, like the appointment of an independent chartered business valuator.
That said, valuing an early-stage company or any technology company for that matter is not an exact science and quite often one or more founders is not happy with whatever valuation is obtained.
Drag and Tag Along Rights
The next, and often less contentious issue leading to a mandatory sale of shares, often agreed to, are drag and tag along rights. In short, where a majority shareholder receives an offer to sell the whole company to a third party, they can compel the minority shareholders to sell their shares on the same terms, to the same third party.
On the flip side, tag along rights allow a minority shareholder to tag along in the event a majority of the company’s shares are being sold. This ensures they can achieve an ‘exit’ at the same time if the majority shareholder is selling his or her shares.
The Founder Relationship as Distinct from the Investor Relationship
The issues that arise between two founders can be quite different from the relationship formed between one founder and one or a group of investors. Investors are often just cutting a cheque, with no expectation that they be involved in operating the business. In those situations, especially for larger institutional investors, they often do not want to agree to things like:
- Non-compete or non-solicit provisions as they may have other investments, or want to make other investments in a similar space;
- The mandatory sale of their shares, unless it is in the context of drag or tag along rights when the entire company is being acquired; or
- The assignment of intellectual property since they are not contributing to the company’s operations.
For that reason, it is sometimes preferable to have the founders and the company enter their own form of agreement, before outside capital is raised and additional investors are brought into the company. At a later stage, a separate form of unanimous shareholder agreement can be entered with any additional investors.
Information Rights
Even if you are a founder, if you are a minority holder and not a board member, you don’t have a statutory right to company information; like bank statements, contracts, internal company documents, etc. While minority shareholders often have the right to attend year-end shareholder meetings, and, if it hasn’t been waived, the right to require the company to undergo a financial audit each year, aside from that, shareholders without contractual information rights can be left flying in the dark on many issues.
Founders may want to document a right to have viewing access to the company’s bank accounts and credit facilities (credit cards, loans, lines of credit etc.) to know the company’s financial position and how their equity holdings are doing. If they are directors, they should be staying on top of this information either way.
Some founder agreements will document information rights which get extended to a founder, even if or when they stop acting as a director. Meaning, they can be given the right to know what the board is doing, what contracts are being entered and approved, what resolutions are being signed, etc.
When you do early-stage financing rounds, you’ll notice some investors demand these types of information rights.
Dispute Resolution
The harsh reality is that courts and the litigation process are often slow and costly. If a dispute arises in the context of your co-founder relationship that is litigated, there often is no winner. Litigation can result in disruptions to the company’s business and large expenses incurred by everyone involved.
One alternative to litigation is to have a private arbitrator hear and settle disputes. While arbitration is not always more cost effective (as you have to pay an arbitrator) many arbitration institutions have expedited arbitration rules, which are intended to shorten the dispute resolution process. This is done primarily by the arbitration rules limiting the parties in the amount of evidence and submissions they can make in connection with the dispute.
There are even some arbitration institutions who will, for a smaller fee, issue a decision without any in-person hearing or reasons for their decision.
Oppression Remedy
Another issue founder agreements can help overcome, or at least mitigate, are the statutory rights minority shareholders have arising under the ‘Oppression Remedy’. In short, the oppression remedy is a catch-all remedy that courts (and arbitrators) can use to consider whether some action the corporation or other shareholders have taken is fair and reasonable, and not contrary to the ‘reasonable expectations’ of the minority shareholders. Founders are often surprised to learn how wide the discretion is that courts have to find remedies to rectify corporate actions that appear unfair to minority shareholders.
A great example is where one founder pays him or herself a salary or dividends (if they held a separate class of shares) to the exclusion of their co-founder (who might not hold a board seat, or who could be out voted). Depending on the circumstances, and even the size of the salary or dividend, it may be regarded as oppressive and unfair in some situations, giving rise to a court deciding it cannot be done. For that reason, the founder agreement is a perfect opportunity to really set what the reasonable expectations of both parties are on these types of issues.
DISCLAIMER: The information in this article is not (and is not intended to be) legal advice. This is legal information only. Reviewing information about the law may help you understand whether you need legal assistance. Whether and how this information applies to your circumstances requires the assistance of legal counsel who can apply the information to your needs. Do not rely on this article to make decisions. You may contact Wires Law, and we would be pleased to determine whether our firm can assist you. No solicitor-client relationship is established until we confirm we can act for you in a legal services agreement. Read our Terms of Use for more information.
John Wires
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