In the realm of business, agreements play a vital role in establishing clarity, defining relationships and protecting the interests of parties involved. Two key types of agreements commonly employed are Founders’ agreements and shareholders’ agreements.
Founders’ agreements set the foundation for collaboration among the founders of a business and address critical aspects such as equity ownership, responsibilities and intellectual property rights. On the other hand, shareholders’ agreements oversee the relationship between shareholders in a company, outlining rights, obligations and mechanisms for decision-making and profit distribution. Understanding the differences between these agreements is important for entrepreneurs and stakeholders alike to ensure effective governance and mitigate potential conflicts.
What is a Founders’ Agreement?
The Founders agreement is a legally binding contract that helps establish a clear understanding among the founders and safeguards their interests in the business venture. It serves as a roadmap for collaboration, addressing various aspects of the founders’ roles, responsibilities and ownership rights.
Key elements and provisions included in a founders’ agreement:
1. Founders’ roles and responsibilities:
The agreement goes on to define what specific roles and responsibilities will be assigned to each founder, so as to ensure clarity and accountability within the team.
2. Equity ownership and distribution among founders:
For the purpose of determining how the ownership of the business will be divided among the founders and even the allocation of shares or ownership percentages, a founders’ agreement is needed.
3. Intellectual property ownership and protection:
To address the ownership and protection of intellectual property which may include patents, trademarks, copyrights, trade secrets, etc.
4. Vesting of founders’ shares:
Founders’ shares may be subject to vesting, which means they earn ownership gradually over a specific period, typically to incentivise long-term commitment and mitigate risks associated with founder departures.
5. Non-compete and non-disclosure clauses:
These clauses prevent founders from competing with the business during their tenure and ensure the confidentiality of sensitive company information.
6. Dispute resolution mechanisms:
The agreement establishes mechanisms for resolving conflicts or disputes that may arise among the founders, such as mediation, arbitration or negotiation.
Importance of a Founders’ Agreement for early-stage startups:
Founder agreements are particularly important for early-stage startups. A strong working relationship is laid by them, goals are aligned and a framework for decision-making is provided. Misunderstandings are prevented, expectations are clarified and the interests of the founders are protected. This becomes particularly important during the vulnerable stages of a startup.
Numerous examples illustrate the significance of founder agreements. For instance, disputes over equity distribution, differing interpretations of roles or disagreements regarding intellectual property rights can lead to significant challenges and even legal battles. Founders who have well-drafted agreements in place are better equipped to navigate such situations, ensuring a smoother journey for their business. Several high-profile cases have emphasised the importance of founder agreements, demonstrating the value of comprehensive and legally sound documentation in protecting founders’ rights and maintaining business stability.
What is a Shareholders Agreement?
This agreement outlines the rights, obligations and responsibilities of shareholders, along with mechanisms for decision-making, profit distribution as well as dispute resolution with the main objective of protecting the interests of shareholders, establishing clear guidelines for governance and ensuring a harmonious relationship among the stakeholders of said company.
Key elements and provisions included in a shareholders’ agreement:
- Shareholders’ rights and obligations: Shareholders agreement is meant to outline the rights and obligations of each shareholder, which includes their voting rights, access to information and participation in key decisions.
- Transfer and sale of shares: These are the conditions and procedures for transferring or selling shares and also provides for any restrictions or pre-emption rights that existing shareholders may have on their part.
- Decision-making processes and voting rights: It also specifies the process of decision making within the company and includes voting thresholds, board representation, etc.
- Dividend distribution and profit sharing: It addresses how profits will be allocated among shareholders, including dividend policies, profit distribution methods and reinvestment provisions.
- Exit strategies and buy-sell provisions: This generally includes provisions for shareholders to make an exit from the company, like rights of first refusal, drag-along and tag-along rights and also the mechanisms for valuing shares during a sale or transfer.
- Dispute resolution mechanisms: One of the most important provisions of a shareholders’ agreement is providing the procedures for resolving disputes among shareholders so as to minimise conflicts and maintain the stability of the company.
Importance of a Shareholders’ Agreement for established companies:
Shareholders agreements become an essential component for established companies where there are multiple shareholders involved. These agreements ensure that shareholders have a clear understanding of their rights and obligations, protect minority shareholders from potential oppression and establish mechanisms for addressing conflicts and decision-making. A well-drafted shareholders agreement can promote transparency, prevent disputes and provide a framework for effective governance and management.
Numerous examples demonstrate the impact of shareholders agreements on companies. For instance, a shareholders’ agreement can be instrumental in resolving conflicts between majority and minority shareholders, ensuring fair treatment and preventing abuse of power. In cases of ownership changes or company sales, a well-drafted agreement can facilitate a smooth transition and protect the interests of all shareholders. Examples from various industries highlight how shareholders agreements have played an important role in maintaining stability, resolving disputes and safeguarding the value of shareholders’ investments.
Key Differences between Founders’ Agreement and Shareholders’ Agreement
Some key differences between a Founders’ agreement and Shareholders’ agreement have been mentioned in the table below:
| Topic | Founders’ Agreements | Shareholders’ Agreements |
| Focus and stage of business | Relationship and responsibilities among founders | Relationship among shareholders in an established company |
| Parties involved and their roles | Founders of the business | Shareholders (founders, investors, etc.) |
| Timing and purpose of implementation | Inception of a business, before company formation | After company establishment, involving multiple shareholders |
| Content and provisions | Founders’ roles, responsibilities, equity distribution, intellectual property ownership, vesting of shares, non-compete clauses | Shareholders’ rights and obligations, transfer and sale of shares, decision-making processes, dividend distribution, exit strategies, dispute resolution mechanisms |
| Legal enforceability and binding nature | Legally enforceable | Legally enforceable |
| Emphasis on trust and collaboration | Strong emphasis | Formal and legally binding |
Factors to consider when Choosing the Right Agreement for Business
When trying to consider which agreement to give priority to, it’s important to take into account several factors. These factors include:
- Stage of the business
- Nature of the relationship among the parties involved
- Specific needs and concerns of the founders and shareholders
- Potential risks and challenges that the business may encounter.
- Assessing these factors will help determine whether a Founders’ agreement or a shareholders’ agreement should be given more emphasis.
Situations where both agreements are necessary:
In many cases, it is advisable to have both a Founders’ agreement and a shareholders’ agreement in place. This is particularly relevant when the founders of a business also hold significant shares in the company. A Founders’ agreement helps establish the foundation for collaboration and outlines the specific roles and responsibilities of the founders. A shareholders’ agreement, on the other hand, governs the relationship among all shareholders, including the founders. Having both agreements ensures that the interests of the founders as individuals and the interests of all shareholders are adequately addressed.
Balancing the interests of founders and shareholders:
In choosing the right agreement, it’s significant to achieve a balance between the interests of founders and shareholders. Founders may place importance on equity ownership, intellectual property rights and roles within the company whereas the Shareholders, including investors, may prioritise decision-making processes, profit distribution and exit strategies. Hence, both the parties’ needs and concerns must be taken into consideration to ensure that the agreements achieve a fair balance between the founders’ vision and the interests of all shareholders.
Final Thoughts
Understanding the key differences between Founders’ agreements and shareholders agreements is important for entrepreneurs and stakeholders alike. Founders’ agreements focus on the internal dynamics and collaboration among founders, while shareholders agreements govern the relationship among shareholders in an established company. Both agreements play essential roles in ensuring clarity, protecting interests and maintaining effective governance.
By considering factors such as the stage of the business, the parties involved and the specific needs of founders and shareholders, the appropriate agreement can be prioritised. Seeking legal advice and customising the agreements based on specific circumstances will help ensure their effectiveness and alignment with the business’s objectives. Properly implemented agreements are fundamental to the success and stability of businesses.
