How To Draft A Cofounder’s Agreement

How to draft a cofounders’ agreement is one of the first tasks you should explore when establishing a startup. Developing a great business idea and a plan for transforming it into a marketable product is only the first step.

While discussing the further steps with your future cofounders, you’ll also talk about drafting a formal contract. This contract should define the terms and conditions of the partnership you’ll enter into. Infusing clarity into your work relationship eliminates the risk of disputes and disagreements.

Statistics indicate that 80% of the companies reaching a $1B-valuation since 2005 had two or more founders. Yet another notable statistic reveals that 43% of founders end up buying out a cofounder because of conflicts. But you can avoid this risk by drafting a detailed cofounders’ agreement.

Before getting to the components, here’s an overview of how to draft a cofounders’ agreement. The initial steps involve discussing the basics of building the business that go beyond the product. Here’s how to get started.

Step 1 – Retain the Services of Expert Legal Counsel

The founders’ agreement is a legally binding contract that defines the business and the relationship between the cofounders. Drafting it and signing it before the company’s incorporation helps lay a robust cornerstone for the organization, free of ambiguities.

Several templates are available online, and you simply need to download and fill in the necessary information. However, since this document is so crucial, getting professional assistance is advisable. You’ll cover all the essential components and ensure you don’t miss any critical details.

An expert attorney will also help you cover aspects that may not seem critical now but influence the company’s operations. Defining each cofounder’s roles, responsibilities, rights, and equity ownership shares ensures efficiency and accountability–essential ingredients for long-term success.

Step 2 – Identifying Underlying Aspects of the Company

Remember that aligning the non-physical goals of the company is as crucial as investing in physical assets and intellectual property (IP). Here are some of the details you need to work out:

Vision and Mission Statement

The cofounders must sit across the table and determine their shared vision and mission for the future of the company. You’ll talk about the shared goals, objectives, and the purpose you hope to fulfill. Keep in mind that 65% of startups fail because of this misalignment and conflicts.

Eliminate this risk by discussing your perspectives and working out answers to issues like:

• Why are we establishing this company?
• What is the problem it will solve, and what are the emotional drivers behind the solution?
• What is the initial product or service we intend to develop? Ensure everyone understands the possibility of strategic pivots if needed.
• How do we hope to scale the company, and what approaches do we intend to deploy?

Even as you work out the answers to these questions, the cofounders must also discuss their core priorities. If you have varying priorities, it makes sense to be upfront about what’s essential for each cofounder. Whether it is on a personal level or for the company’s future, present all perspectives.

For instance, one of the cofounders’ goals could be to make good money and walk away with substantial returns. For another, it could be about making a difference in their industry or location. Yet another cofounder could dream about building a unicorn with a $1B valuation.

While none of their respective goals are good or bad, aligning the key motivations is crucial. Being aware of each other’s aspirations also eliminates conflicts later.

Company Culture and Work Ethics

Instituting a robust work culture at the onset is a vital step in how to draft a cofounders’ agreement. You’ll build a culture centering around values, beliefs, and ethics. Culture defines the interpersonal relationships that executives and team members share within the organization.

It also describes how they interact with other stakeholders–investors, customers, vendors, and other third-party partners and collaborators. Culture can also be about behavior, dressing styles, language, and delivering top-notch products and services to customers.

Always remember that establishing this vital company aspect starts with the top-tier management and percolates throughout the organization. This is why it is essential to set down the ground rules at the very beginning. These rules will also govern the new employees you hire and their salary structure.

A strong culture built around non-negotiable ethics and work standards influences not just decisions but also customers’ perceptions. You’ll evoke loyalty while establishing the company’s credibility and reputation. People will know just what to expect during their business dealings.

Culture goes beyond regulatory compliance with sustainability practices and adopting ESG rules. It influences the kind of employees, clients, business partners, and investors you attract. And, the work environment you develop for the day-to-day functioning.

Is this important? Statistics show that a strong, well-aligned company culture can raise employee engagement by an incredible 72%. Work with your cofounders to determine this vital aspect and add the details to the cofounders’ agreement.

Measuring Success Beyond Metrics

Measuring the company’s success is not just about verifiable metrics like sales figures, profits, cash flows, revenues, or annual performance. Success can also center around whether the cofounders see the company’s goals being achieved.

This section of the cofounders’ agreement will outline each cofounder’s goals–which are not just about the product. For example, it could be about finding a practical solution for a specific waste product that can be recycled. Or, delivering products to fill an urgent need in a particular community.

This measure of success is about how effective the company is in reducing the waste delivered to landfills. Or, if the community is benefiting from the products the company makes.

Identifying Cofounder Ambitions and Exit Strategies

Savvy entrepreneurs should be ready with their exit strategies when building their ventures. Having a rough pathway in mind for the future of the company helps them plan well ahead of time. You might envision entering into a merger or acquisition (M&A), or licensing or franchising the IP you develop.

Alternatively, you consider retiring or taking the company public with an Initial Public Offering (IPO). Some founders also anticipate gradually liquidating their ownership stake to invest in new projects. When there are two or more cofounders, you’ll have this conversation early on.

Even as you’re understanding how to draft a cofounders’ agreement, ensure that each person is clear about their ambitions. For instance, if one cofounder foresees selling the company, others may not be interested in accepting an offer. The company becomes a part of their identity.

Accordingly, you can add clauses and provisions in the contract to plan for these contingencies. The remaining partners can offer to purchase the stake when one cofounder is ready for an exit. Being clear on expectations is always advisable.

Any of the cofounders may have expectations of a tentative exit horizon or the minimum returns they hope to earn. Or, say a partner intends to exit when you reach a specific milestone, like raising the series A. In that case, the funding round could be their trigger.

Keep in mind that storytelling is everything in fundraising. In this regard, for a winning pitch deck to help you here, take a look at the template created by Peter Thiel, Silicon Valley legend (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.

Remember to unlock the pitch deck template that founders worldwide are using to raise millions below.

Exploring Cofounders’ Risk Tolerance

Being clear on everyone’s risk tolerance is another aspect of how to draft a cofounders’ agreement. Every partner will be investing capital, time, skill sets, or other assets, and they all have expectations of returns. But you also need to be prepared for the possibility that the company may not succeed.

Accordingly, you need to talk about how to handle potential losses. As long as the company has not been registered as an independent entity, all the partners are responsible for its assets and debts.

This is why the cofounders’ agreement should specify how they will share them in case the company fails. Or, if you decide to terminate the partnership or dissolve the company.

For instance, a partner commits to investing capital in increments through a specific period in its lifecycle. In that case, the contract should specify the returns and interest they will receive.

Let’s try another. One of the cofounders wants to limit the liability they can carry in the event the company goes into debt. The attorney will mention the arrangement that the partners arrived at to accommodate this request.

Step 3 – Determining the Basic Elements for Operational Success

Aside from the non-physical aspects of how to draft a cofounders’ agreement, you need an overview of its operational aspects. You’ll find more detailed information here, but let’s list them quickly.

• Names and addresses of the cofounders
• The company’s type, name, structure, and location, and other relevant details
• Capital and other asset contributions, including expertise and intellectual property (IP)
• Ownership and equity structure
• Salary and compensation structure for cofounders
• Cofounder roles and responsibilities
• Decision-making and voting rights
• Intellectual property (IP) ownership
• Maintaining confidentiality and securing company secrets
• Founder exit protocols and non-compete provisions
• Dispute resolution
• Handling income and expenses, as well as tax obligations
• Terminating the cofounders’ agreement
• Dissolving the company

With the advice of your legal counsel, you’ll add other clauses according to the sector, product type, and customer base. The professional will also guide you through the provisions specific to the state and geographical location to ensure compliance.

They may add more clauses depending on the complexity of the product and its features. Since each company, its cofounders, structure, and goals are unique, the contract will cover all the essential elements. This step ensures the startup is set up for success from the beginning.

Step 4 – Discussing and Negotiating

This step in understanding how to draft a cofounders’ agreement is about extensive discussions and negotiations. Expect some amount of back and forth as the cofounders present their opinions and request changes. This process could take a couple of weeks or even longer.

Resolving differences at this stage and putting down decisions in writing helps avoid conflicts later. At the same time, understand that the cofounders’ agreement is not set in stone. Although it is a legally binding contract, it can be amended as the company evolves and grows.

When drafting the agreement, the cofounders can contact their individual legal representatives to review the first draft and clarify doubts. Connecting with other entrepreneurs and knowledgeable entities within your network is advisable.

Depending on the feedback, your legal counsel will make the desired changes and create subsequent drafts. Once all the cofounders agree to the terms and conditions, you can continue with the next steps.

Final Step

Each cofounder receives soft copies of the finalized document for review. Next, the attorney creates hard copies in compliance with state and federal regulations and preps them for signing. The cofounders now sign and date the copies for everyone to hold securely.

They may also preserve an electronic copy with digital signatures for future reference as an extra layer of protection.

Working out the basics about your company’s structure and cofounders’ relationship is only one of the many aspects of startup building. If you need more information about how to launch a company, check out this video I have created.

Documents to Include with the Cofounders’ Agreement

You don’t need to worry about formal governmental filings, similar to when you register a company, when crafting the agreement. However, your legal advisor may ask for certain documents to ensure that they create and execute the contract effectively.

They’ll want to confirm the authenticity of the information they are adding to the agreement. Here are some of the paperwork and details they may ask for:

• Full names of all the cofounders to identify them accurately
• Addresses and contact information for legal purposes and communication
• Proof of identity, such as a driver’s license or passport, to verify and record
• Company name, if it has already been finalized, or a provisional name
• Company Registration Certificate if the company has already been formally incorporated. You’ll attach the document that confirms its legal identity as a standalone entity.
• Proof of Intellectual Property (IP), including patents, copyrights, trademarks, and logos that the company owns

How To Draft A Cofounder’s Agreement – The Takeaway!

A detailed and expertly crafted cofounders’ agreement creates a framework for building the company. By specifying the partners’ expectations and obligations, it sets up the organization for sustained growth and success. It also acts as a crucial reference point in case of disagreements and conflicts.

It’s always advisable to bring in a professional legal advisor to assist you in drafting this crucial set of documents. They will make sure to include all the essential information needed to keep the partnership on track.

You may also find our free library of business templates interesting. There, you will find every single template you need to build and scale your business completely, all for free. See it here.