The Imperative Of Founders’ Agreement For Indian Startups

In the dynamic and burgeoning landscape of global entrepreneurship, the foundation of any successful startup venture lies in the clarity and coherence of its legal framework. Yet, amidst the whirlwind of innovation and ambition, the importance of a robust founders’ agreement often remains overlooked, leading to potentially devastating consequences.

Research has consistently underscored a sobering reality: a staggering 65% of startups face failure due to internal disputes among founders. In the Indian context, where the startup ecosystem is burgeoning, the absence of a well-structured founders’ agreement can exacerbate risks and vulnerabilities, exposing startups to legal quagmires and operational uncertainties that can impede growth and sustainability.

The founders’ agreements are drafted with the intention of providing standard procedures for dealing with possible hurdles/situations that may arise during the lifetime of the enterprise. 

Here are some of the key contentious issues dealt with by the founders’ agreement and form an integral part of such agreements.                                              

Roles And Responsibilities

In the absence of a formal agreement, individual expectations regarding roles, contributions, and decision-making authority remain undefined paving the way for confusion, resentment, and power struggles, jeopardising the venture’s stability and growth. 

A well-defined framework for roles and responsibilities ensures clarity, fosters accountability, and mitigates internal discord.

Business Decision-making

In the best interest of the company’s success, it is imperative to establish a structured mechanism for decision-making to facilitate progress and growth. 

The allocation of decision-making power should align with the respective shareholding patterns of each co-founder. By incorporating such mechanisms, many potential disputes can be preemptively avoided. 

This proactive approach ensures that decisions are made smoothly and efficiently, enhancing operational agility and enabling the company to navigate challenges and capitalise on opportunities with greater ease.

Deadlocks

Deadlock scenarios can bring operations to a standstill, jeopardising the venture’s stability and growth. Explicit provisions for decision-making powers, along with dispute resolution mechanisms, are imperative to navigate impasses swiftly and effectively, safeguarding operational continuity.   

Equity Split And Vesting Schedule

Equity allocation, coupled with a vesting schedule, is a linchpin for ensuring fairness and alignment of interests among founders. The agreement should clearly demarcate the equity split between the founders based on their domain expertise, capital invested and level of involvement in the operation of the enterprise. 

In addition to the above it is pertinent to provide for a vesting schedule and not remit all the proposed allotted shares to the founders all at once to ensure their contributions towards the company do not wane. 

The vesting schedule shall also provide for the treatment of unvested shares in the event any of the founders either leave the venture prematurely or their association with the business is terminated.    

Intellectual Property Ownership

Intellectual property assets are invaluable assets for startups, yet ownership rights can be ambiguous without clear delineation. Defining ownership rights, permitted uses, and commercialization avenues safeguards against disputes, ensuring the protection and monetization of intellectual property assets.

Remuneration

The enterprise should from the get-go unambiguously identify the remuneration payable to the founders and the compensation, bonuses, etc., payable to them upon the completion of certain milestones.  

Transfer Of Shares

The agreement must clearly enumerate the rights and restrictions pertaining to the transfer of shares. The provision of “lock – in periods” restricts the founders from transferring shares prior to the lapsing of such term and protects the business from uncertainty and ambiguity at the nascent stage of their existence; or “Right of first refusal” which allows the other founders the first right to purchase shares from a founder desirous of disposing of their shareholding. 

Exit Strategy

A well-defined exit strategy anticipates and mitigates potential founder departures, averting protracted legal battles and reputational damage. Clarity on exit mechanisms, valuation methodologies, and buyback provisions ensures smooth transitions and protects the interests of all stakeholders. 

What If There’s No Founders’ Agreement?

Keeping in mind the above key clauses, here are a few noted downsides of not having a founders’ agreement in place.

First, the business may have trouble raising funds since investors often view the lack of a founders’ agreement as a red flag, signifying potential internal conflicts and the absence of a long-term vision, thereby affecting the long-term health of the business.   

Disputes arising without a written agreement entail complex legal proceedings, consuming resources, and hampering business operations. High-profile cases, such as those involving Housing.com, Apple Inc, Facebook, Snapchat and Netflix, serve as cautionary tales of the perils of operating without a founders’ agreement.

For instance, the existence of a founders’ agreement could have helped prevent the much-talked-about disputes such as 

• Steve Wozniak vs Steve Jobs and Wozniak’s controversial departure from Apple Inc. 
• Founder of Facebook Eduardo Saverin vs Mark Zuckerberg where Saverin’s shareholding was significantly diluted leading to his exit from the company; 
• Evan Spiegel vs Reggie Brown, the founders of Snapchat which led to the unceremonious exit of Brown from the company, the resultant lawsuit and a legal settlement; 
• A dispute closer to home which led to 9 out of 12 founders of the home-grown startup Housing.com departing due to internal conflicts. 

The above-mentioned disputes are an example of how the absence of a founders’ agreement can ruin businesses as well as the personal relations of the individuals involved.      

In conclusion, a founders’ agreement serves as a linchpin for the long-term viability and sustainability of Indian startups. Investing in its formulation not only mitigates legal and operational risks but also fosters a culture of transparency, accountability, and collaboration essential for navigating the volatile startup landscape and achieving sustainable growth.

Note: We at Inc42 take our ethics very seriously. More information about it can be found here.