Starting a business with a co-founder is like entering into a marriage—it's exciting, full of potential, and carries a deep sense of commitment. But just like any strong partnership, it needs a solid foundation to weather the inevitable challenges ahead. That’s where a co-founder agreement comes in.
This document isn’t just legal mumbo jumbo; it’s your roadmap for navigating the ups and downs of startup life together. It spells out who does what, who owns what, and what happens if things don’t go as planned.
Without it, you’re flying blind, risking misunderstandings, disputes, and even the collapse of your company. In this guide, we’ll walk you through everything you need to know to create a robust co-founder agreement. It will ensure that both your business and your relationship with your co-founder remain strong, no matter what comes your way.
1. Understanding the Importance of a Co-Founder Agreement
Why It’s Non-Negotiable
Imagine you and your co-founder are climbing a mountain—without a rope tying you together. You’re halfway up when you realize you’ve been climbing in different directions. That rope? That’s your co-founder agreement.
It’s non-negotiable because it legally binds you both to a shared vision and a fair path forward, even if things get rocky. A handshake or a verbal agreement might feel like enough when you're in the honeymoon phase of your startup.
This is rightfully so. But, once real challenges hit (and they will), you’ll need something concrete to fall back on. This agreement isn’t just about legal protection; it’s about setting the groundwork for trust and clear expectations from the get-go.
When to Create One
Timing is everything. The best time to draft a co-founder agreement is as early as possible—ideally before you’ve even registered the company.
Think of it as laying the foundation before building the house. Once money starts coming in or investors start asking questions, the stakes get higher. If you delay, you risk entangling yourself in disputes that could’ve been easily avoided with an agreement in place.
So, get it done before the first dollar hits the bank. Get it done before equity is issued. Oh, and definitely get it done before any significant business decisions are made.
Common Misconceptions
One of the biggest misconceptions is that if you trust your co-founder, you don’t need an agreement. Trust is important, but it’s not a substitute for clarity.
Another myth is that an agreement is only necessary if you plan on raising venture capital. While VCs will certainly require it, the truth is, even bootstrapped startups benefit immensely from it.
I always say that a clear, written agreement is the best agreement. The goal isn’t just to protect the business—it’s to protect the relationship between co-founders, which can be just as valuable.
2. Defining Roles and Responsibilities
Role Clarity
You wouldn’t have two captains steering the same ship, right? The same logic applies to your startup. Defining roles clearly is crucial to avoid stepping on each other’s toes.
Each co-founder should have a specific set of responsibilities, aligned with their strengths. If one of you is a tech whiz, let them focus on product development, while the other handles marketing or business strategy.
The key is to play to each other’s strengths and make sure everyone knows who’s accountable for what. This way, when a challenge arises, you won’t waste time figuring out who’s supposed to deal with it—you’ll already know.
Decision-Making Power
Decision-making can be the Achilles’ heel of co-founder relationships. It’s essential to establish who has the final say on key decisions.
Are decisions made by consensus, or does one co-founder have the final veto power in certain areas?
Maybe one of you gets the final word on product, while the other has authority over finances.
The last thing you want is to be stuck in a deadlock when time is of the essence. Clear decision-making structures help you move quickly and avoid unnecessary conflicts.
Handling Overlaps
Even with clearly defined roles, there will be overlaps—areas where both of you might have input. This is natural but can lead to confusion or tension if not handled well.
To manage overlaps, create a system where both voices are heard, but one person has the lead. For instance, if both co-founders have a say in hiring decisions, decide upfront who makes the final call.
By establishing this hierarchy within overlaps, you ensure that decisions are still being made efficiently. Not to forget, without stepping on each other’s toes.
3. Equity Split and Vesting Schedules
Determining the Split
Equity distribution can be the most contentious part of the agreement. It’s not just about who came up with the idea or who is putting in the most hours.
You need to consider factors like experience and initial financial contributions. Do not forget the roles each founder will play moving forward. A 50/50 split might seem fair at first glance, but it often leads to problems down the road.
Instead, have an open, honest discussion about contributions and expectations. Agree on a split that reflects the true value each of you brings to the table.
Vesting Periods
A vesting schedule is like a prenup for your equity. It ensures that no one walks away with a large chunk of the company after contributing very little. Typically, vesting happens over four years, with a one-year cliff.
This means that if a co-founder leaves within the first year, they get nothing. After that, they earn their shares gradually.
This approach not only protects the company but also incentivizes co-founders to stick around. This will keep them pushing the business forward.
Cliff Periods
The cliff period is your startup’s safety net. Imagine you give a co-founder 20% of the company, and they leave after three months. Without a cliff, they take that 20% with them, even though they didn’t stick around long enough to truly earn it.
A one-year cliff prevents this by ensuring that equity only starts vesting after a certain period (usually 12 months). If they leave before the cliff period ends, they leave with nothing.
This is crucial in protecting the equity for those who are genuinely committed to the long haul.
4. Intellectual Property (IP) Ownership
Assigning IP Rights
Intellectual property can be the crown jewels of your startup, and assigning IP rights correctly is vital.
Here’s the deal: anything created during the course of the business by the co-founders should belong to the company, not the individual. This includes code, designs, business plans, and even customer lists.
Clearly assigning IP rights to the company in your agreement ensures that all the valuable work you’re doing isn’t tied to one person. If a co-founder leaves, you don’t want them walking away with the company’s core assets. This is about protecting the heart of your business.
Handling Existing IP
Sometimes, a co-founder might come into the partnership with existing IP. Maybe it’s a piece of software they developed before joining. Even bigger- maybe it is a brand they’ve already built. You need to decide how this IP will be handled.
Will it be transferred to the company? Licensed? Retained by the individual? These decisions need to be made early on and included in the agreement.
For example, if your tech co-founder is bringing a proprietary algorithm into the startup, ensure it’s clear who owns it and how it can be used. This clarity prevents future disputes and ensures everyone knows what’s on the table.
IP Transfer Protocols
Imagine one of your co-founders decides to exit the company. What happens to the intellectual property they helped create? This is where IP transfer protocols come in.
You need to set clear guidelines for how IP is handled if a co-founder leaves—whether it’s due to resignation, termination, or other reasons. The agreement should state that all IP developed during their tenure transfers to the company. It should do so automatically.
Also, add provisions that restrict the exiting founder from using or claiming the IP in future ventures, especially if they are in the same industry. This keeps your startup’s competitive edge intact.
5. Compensation and Salary Expectations
Setting Early-Stage Salaries
Compensation is a touchy subject, especially in the early days when cash is tight.
The big question: how much should you pay yourselves? Most founders take minimal salaries—or none at all—in the beginning.
This shows investors that you’re committed and ensures more money stays in the business.
However, you should still set clear expectations in your agreement. If you plan on taking a small salary, document it.
Also, include provisions to revisit salaries after the company is profitable or funded. This avoids resentment down the line when one founder feels they’re shouldering more financial burden than the other.
Equity vs. Cash Compensation
Balancing equity and cash compensation is crucial, especially when your startup is cash-strapped. Equity compensation—giving co-founders more shares instead of cash—can offset low salaries in the early stages.
However, this needs to be done carefully. The agreement should outline how much equity is being granted in lieu of salary and under what conditions.
Will these shares be subject to vesting? What happens if the company can suddenly afford higher salaries?
Clarifying these details ensures that both cash and equity compensation are fair and aligned with the company’s growth.
Future Salary Revisions
As your startup grows, so too should your compensation—at least, that’s the hope. But when do you give yourselves a raise? The agreement should include a roadmap for future salary revisions.
You can have this tied to specific milestones like revenue targets or funding rounds.
For example, you might agree that once the company reaches a certain monthly recurring revenue (MRR), you’ll revisit and possibly increase salaries. This ensures that everyone knows when and how compensation might change. Thus, preventing any future disagreements about money.
It also helps maintain fairness, especially if one co-founder is more involved in driving the company’s financial success.
6. Decision-Making and Dispute Resolution
Voting Mechanisms
Making decisions in a startup is like steering a ship through rough seas—one wrong move can throw everything off course. That’s why having clear voting mechanisms in place is essential.
In your agreement, you should define how decisions will be made—whether by majority vote, unanimous consent, or another method.
For instance, major strategic decisions (like pivoting the business model) might require unanimous consent. All the while, smaller operational decisions could be handled by a simple majority.
These rules help ensure that decisions are made efficiently while giving each co-founder a voice in the process.
Mediating Disputes
Even with the best communication and intentions, disputes between co-founders can arise. When they do, it’s crucial to have a method for resolving them that doesn’t involve going to court.
Including a mediation clause in your agreement can save you a lot of time, money, and stress. This clause should outline that if a dispute can’t be resolved internally, the co-founders will engage a neutral third-party mediator to help find a solution.
Mediation is often faster and less adversarial than litigation. It also helps preserve the working relationship between co-founders.
Exit Clauses
Sometimes, despite all efforts, a dispute can’t be resolved, and one co-founder decides it’s time to part ways. Your agreement should include exit clauses that define the process for an orderly exit.
This includes buyout options, non-compete clauses, and the process for transferring responsibilities. An exit clause ensures that if a co-founder leaves, the business can continue to operate smoothly.
Thus, without being disrupted by the departure. It also protects the remaining co-founders from having the company’s future tied up in lengthy negotiations or legal battles.
7. Exit Strategies and Buyout Clauses
Defining Exit Scenarios
Exit scenarios are the what if clauses of your co-founder agreement.
What if a co-founder wants out? What if they’re forced out? These scenarios need to be clearly defined to ensure there’s a smooth process in place.
Voluntary exits might include a co-founder deciding to leave to pursue another opportunity. On the other hand, involuntary exits could involve a founder being asked to leave due to underperformance or misconduct.
Defining these scenarios helps everyone understand their rights and obligations. It makes sure there are no surprises if and when someone decides to move on.
Buyout Terms
If a co-founder exits, how do you handle their shares? This is where buyout terms come into play. Your agreement should detail how the exiting co-founder’s equity will be valued and who has the right to buy those shares.
Will the company itself buy them back, or will the remaining co-founders have the first right of refusal?
The buyout terms should also include how the price will be determined. It may be based on a pre-agreed formula, the company’s latest valuation, or an independent appraisal.
This ensures a fair and transparent process. It also helps in preventing conflicts over money. Especially when emotions might already be running high.
Non-Compete and Non-Solicitation Clauses
When a co-founder leaves, you don’t want them to become your direct competitor or poach your team. This is why non-compete and non-solicitation clauses are essential.
A non-compete clause prevents the exiting co-founder from starting or joining a competing business. It does so for a specified period and within a certain geographic area.
Meanwhile, a non-solicitation clause stops them from trying to recruit your employees or lure away clients. These clauses protect your startup’s interests.
They ensure that a departing co-founder can’t use the knowledge and connections they gained at your company against you.
8. Handling Dilution and Future Funding
Understanding Dilution
Dilution is one of those topics that can sneak up on you if you’re not careful. Every time your startup raises money, new shares are issued. This dilutes the ownership percentage of existing shareholders, including co-founders.
It’s important to understand how dilution works and to include provisions in your agreement that address it.
For example, your agreement might include a clause that allows co-founders to purchase additional shares during future funding rounds to maintain their ownership percentage.
Planning for dilution ensures everyone knows what to expect as the company grows and raises capital.
Preemptive Rights
Preemptive rights give co-founders the first option to buy new shares before they’re offered to external investors. This is crucial if you want to maintain your ownership percentage during future funding rounds.
Without preemptive rights, you might find your stake in the company shrinking faster than you’d like. Including preemptive rights in your agreement protects your interests.
They let you join future rounds and keep your share of the pie. It protects your influence in the company. It ensures that, as new investors come in, the co-founders still have a say in running the business.
Anti-Dilution Clauses
Anti-dilution clauses are a bit more advanced, but they can be a lifesaver. These clauses protect co-founders from significant dilution in certain situations.
An example is a down round, where new shares are issued at a lower price than in previous funding rounds. There are types of anti-dilution protection, like full-ratchet or weighted-average.
Your agreement should specify which, if any, apply.
These clauses can complicate future funding rounds. But, they are essential. They ensure that early co-founders don't see their ownership severely diluted as the company raises more capital.
9. Confidentiality and Non-Disclosure Agreements (NDAs)
Importance of Confidentiality
Startups thrive on their ideas, innovations, and strategies—all of which need to be protected. Your co-founder agreement must keep sensitive information within the company.
You must protect your sensitive info, like product plans, customer lists, and financial data. It must not fall into the wrong hands, especially if a co-founder exits.
A confidentiality clause binds all co-founders to keep the company’s secrets, well, secret. This protection is vital. It keeps your edge and your startup's secrets safe.
NDA Clauses to Include
When drafting NDAs as part of your co-founder agreement, there are a few key clauses you’ll want to include. First, define confidential information. It could be anything from business plans to customer data.
Next, specify the duration of the NDA—how long do the confidentiality obligations last? Typically, this can range from a few years to indefinitely, depending on the nature of the information.
You’ll also want to include a clause that covers what happens if someone breaches the NDA, such as financial penalties or legal action.
These clauses create a clear, enforceable way to protect your startup's sensitive info.
Exceptions to NDAs
Not all information can be kept confidential forever. Your NDA should also outline any exceptions where disclosure might be allowed.
Common exceptions include disclosures required by law (e.g., during legal proceedings) or information that becomes public through no fault of the co-founders.
It’s also important to consider scenarios where information might need to be shared with potential investors or partners.
Defining these exceptions in your agreement helps balance the need for confidentiality with the practical realities of running and growing a business.
10. Handling Conflict of Interest
Identifying Potential Conflicts
In the dynamic world of startups, conflicts of interest can pop up when you least expect them.
Your co-founder may be considering advising a similar company. Or, they might be investing in a project that could distract them.
Recognizing these potential conflicts early is crucial. Sit down together and brainstorm scenarios that could pose conflicts based on your industry and individual backgrounds.
By spotting these situations early, you build trust and transparency. It keeps everyone's priorities aligned with the startup's success.
Establishing Clear Boundaries
Once you've identified potential conflicts, it's time to draw some lines in the sand. Your co-founder agreement should define a conflict and banned activities.
For example, you might agree that no co-founder can engage in business activities that compete directly or indirectly with your startup. Additionally, specify guidelines for external engagements like consulting or speaking gigs.
These boundaries protect the company. They also clarify what's acceptable for co-founders, so there's no guessing.
Disclosure Requirements
Even with clear boundaries, situations will arise that require disclosure. Your agreement should include a robust disclosure policy mandating that co-founders promptly inform each other about any potential conflicts as they emerge.
This could involve opportunities that, while not directly competitive, may impact a co-founder’s time or decision-making impartiality.
Establish a process for how disclosures are made and addressed—perhaps through a formal meeting or written notice.
This openness allows the team to assess and manage conflicts effectively, maintaining integrity and trust within the leadership.
11. Death, Disability, and Divorce Clauses
Death Clauses
It's uncomfortable to think about. I know that. But planning for the unexpected is a hallmark of responsible entrepreneurship. A death clause in your co-founder agreement defines what happens to a co-founder's shares and duties if they die.
Typically, the agreement would specify that the deceased co-founder's shares can be bought back by the company or the remaining founders, often at a predetermined valuation or formula.
This prevents shares from automatically transferring to heirs who may not have the skills, interest, or alignment to contribute to the business, thereby safeguarding the company's continuity and stability during a challenging time.
Disability Provisions
It's also important to plan for scenarios where a co-founder becomes incapacitated and can't fulfill their duties. Disability provisions should define a disability (e.g., inability to work for a time).
They should detail how to reallocate responsibilities and possibly buy back shares.
Consider including terms that allow for temporary adjustments versus permanent ones, depending on the situation's severity and prognosis.
This ensures that the company can continue operating smoothly while also treating the affected co-founder fairly and with compassion.
Divorce and Marital Property
Believe it or not, a co-founder's personal life can have significant implications for your startup, particularly in the event of a divorce. Depending on marital property laws, a spouse could claim a portion of a co-founder's shares, introducing an uninvolved party into your business.
To prevent this, include clauses that require co-founders to have prenuptial or postnuptial agreements specifying that their shares are separate property.
Alternatively, the agreement can mandate that in the event of a divorce, the company or other founders have the right to purchase the shares from the ex-spouse.
Addressing this proactively shields the company from unexpected ownership changes and potential conflicts.
12. Regular Reviews and Amendments
Scheduling Regular Reviews
Your startup today might look very different a year from now, and your co-founder agreement should evolve accordingly. Schedule regular reviews—perhaps annually or after major milestones—to assess whether the agreement still fits your company's needs and circumstances.
These reviews provide an opportunity to reflect on what's working, address any new issues that have arisen, and make necessary adjustments.
Regular check-ins ensure that all co-founders remain on the same page and that the agreement continues to support the company's growth and changing dynamics.
How to Amend the Agreement
When changes are needed, having a clear amendment process is essential. Your original agreement should outline how amendments can be made—typically requiring a written document signed by all co-founders. Specify whether unanimous consent is needed or if a majority can approve changes.
This process ensures that updates are made thoughtfully and with proper consideration from all parties. Keep in mind that significant amendments may also require legal review to ensure compliance with current laws and to maintain the agreement's enforceability.
Getting Legal Advice
Even if you're tempted to handle everything in-house, involving a legal professional in drafting and revising your co-founder agreement is a wise move.
Lawyers specializing in startup law can provide valuable insights, spot potential issues you might have missed, and ensure that the document is legally sound.
Regular consultations, especially during reviews and amendments, help keep the agreement aligned with any new regulations or legal precedents.
Investing in good legal advice upfront can save you from costly disputes and complications down the road.
13. Signing and Legal Formalities
Getting Everyone on Board
You’ve drafted the perfect co-founder agreement, but it’s just paper unless everyone agrees to it. The first step in finalizing the agreement is making sure all co-founders are on the same page.
This means more than just getting signatures—it’s about ensuring everyone truly understands and agrees with the terms. Take the time to discuss the agreement thoroughly, address any concerns, and make any last-minute adjustments.
The goal is to have each co-founder feel confident that the agreement is fair and reflective of your shared vision for the company. When everyone’s in agreement, you’re ready to move on to formalizing it.
Notarization and Witnesses
Depending on your jurisdiction, notarization or having witnesses present during the signing of the agreement might be necessary to ensure its enforceability.
Notarization involves a licensed notary public who verifies the identities of the signatories and witnesses the signing of the document. This extra step can add a layer of security, making it harder for anyone to later claim they didn’t sign the document willingly or knowingly.
Even if it’s not legally required, notarization can be a good idea for the added peace of mind it provides. Similarly, having witnesses can serve as additional verification that the agreement was signed under the right circumstances.
Storing the Agreement
Once the agreement is signed and notarized, you need to store it securely. This isn’t a document you want getting lost in a pile of paperwork.
Consider storing physical copies in a safe, such as a fireproof and waterproof one, and also keeping digital copies in a secure, cloud-based storage service that offers encryption.
Make sure all co-founders have access to these copies and know where to find them if needed. Proper storage ensures that the agreement is easily accessible for reference or legal purposes, without any risk of it being tampered with or misplaced.
14. Consequences of Not Having a Co-Founder Agreement
Case Studies of Failures
The startup world is full of cautionary tales where the absence of a co-founder agreement led to catastrophic results.
Consider the case of Twitter, where disagreements among the co-founders about roles, equity, and vision led to multiple high-profile exits and a lot of bad blood. Here is a more in-depth source for you to read.
Or look at Snapchat’s early days, where disputes over who contributed what nearly derailed the company before it even got off the ground. These real-world examples highlight how even the most promising startups can be derailed by co-founder disputes that could have been avoided with a clear, well-drafted agreement. You can read more about the internal Snapchat dispute here.
Risks to the Business
Without a co-founder agreement, your startup is walking a tightrope without a safety net. Disagreements over roles, equity, or direction can escalate quickly, potentially leading to legal battles that drain your resources and energy.
Investors may be wary of backing a company where co-founder relationships are not clearly defined, and in the worst-case scenario, a lack of agreement can result in the company dissolving altogether.
The risk to your business is not just hypothetical—it’s very real and can have lasting repercussions on your startup’s ability to survive and thrive.
Personal Relationships at Stake
Starting a business with someone often begins as an exciting adventure between friends or trusted colleagues. However, when things go wrong and there’s no agreement in place, the impact on personal relationships can be devastating.
Disagreements over business matters can spill over into your personal lives, leading to fractured friendships or strained family ties. The emotional toll can be as significant as the financial or operational impact on the business.
A co-founder agreement helps protect these personal relationships by providing a clear framework for resolving disputes and ensuring that business issues don’t become personal ones.
Conclusion
A well-crafted co-founder agreement is more than just a legal safeguard—it’s a blueprint for collaboration, clarity, and mutual respect. By taking the time to address key issues like roles, equity, and exit strategies upfront, you’re not only protecting your business but also nurturing the partnership at the heart of your startup.
This agreement lays the groundwork for trust and sets clear expectations, allowing you and your co-founder to focus on what really matters: building something great together.
Remember, it’s not just about avoiding conflicts—it’s about ensuring that when challenges arise, you have a shared understanding of how to move forward. With this agreement in place, you’re ready to tackle the startup journey head-on, confident that you’re prepared for whatever comes your way.
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