Founders Agreement: What To Review Before A New Deal Or Raise

Launching a business with co-founders is exciting, but it can quickly become complicated if you do not have clear ground rules. Many founders rush into new deals or fundraising rounds without reviewing or updating their founders agreement. This can lead to confusion about ownership, decision-making, and what happens if someone leaves the company. Common mistakes include failing to document equity splits, ignoring vesting schedules, and not addressing what happens if a founder exits. This guide explains what a founders agreement is, why it matters, and what you should review before signing a new deal or raising capital. Whether you are starting your first business or preparing for your next funding round, understanding these basics will help you avoid costly disputes and keep your business running smoothly. We will cover practical examples, state law caveats, and checklists to help you get it right.

What Is a Founders Agreement?

A founders agreement is a contract between the original founders of a startup or business. It spells out each founder's rights, responsibilities, equity ownership, and what happens if someone leaves or if the business faces major changes. While not legally required in every state, a founders agreement is a practical tool to prevent misunderstandings and disputes down the road.

At its core, a founders agreement covers:

• Equity splits and ownership percentages
• Roles and responsibilities of each founder
• Decision-making processes
• Vesting schedules for equity
• Intellectual property (IP) ownership and assignment
• What happens if a founder leaves (voluntarily or involuntarily)
• Dispute resolution methods
• Confidentiality and non-compete clauses

Unlike company bylaws or an operating agreement, which are required for certain business structures, a founders agreement is usually an internal contract. However, it is often referenced in other legal documents and is almost always requested by investors during due diligence.

Federal law does not require a founders agreement, but state laws and your chosen business structure (such as LLC, C-corp, or S-corp) may affect what should be included. For example, Delaware and California have different corporate requirements, and your agreement should not conflict with your company's official governance documents. In some states, certain provisions (like non-competes) may be unenforceable or require special language.

Example: Three friends start a tech company in Texas. They verbally agree to split ownership equally, but do not write anything down. A year later, one founder wants to leave and take their full third of the company. The others feel this is unfair, since much of the work is still ahead. Without a written founders agreement, they have no clear process for resolving the dispute, and it becomes a major distraction just as they are about to pitch to investors.

Key Elements to Review Before a New Deal or Raise

Before you bring on new investors, sign a major deal, or start a funding round, it is essential to review and update your founders agreement. Here are the most important areas to focus on, with practical examples and state law caveats:

• Equity Ownership: Are the equity splits still accurate? Have you accounted for any new co-founders or changes in contributions? If you have issued stock options or brought in advisors, make sure these are reflected. State caveat: Some states, like Delaware, require you to update your cap table and file changes with the Secretary of State for corporations.
• Vesting Schedules: Does your agreement include a vesting schedule, such as a standard four-year vesting with a one-year cliff? This protects the company if a founder leaves early. Example: In California, investors often expect a vesting schedule to ensure founders stay committed.
• Roles and Responsibilities: Have any roles changed? Are job titles and duties clearly defined? As your company grows, founders may take on new roles or shift responsibilities. Tip: Spell out who is responsible for product, sales, fundraising, and operations.
• IP Ownership: Is it clear that all intellectual property created by founders belongs to the company? Example: A founder who develops code or branding before incorporation should assign those rights to the company in writing. State caveat: Some states require specific assignment language for IP transfers to be valid.
• Founder Departures: What happens if a founder resigns, is terminated, or becomes disabled? Is there a buyback or repurchase option for their shares? Example: In New York, a departing founder may be entitled to fair market value for their shares unless the agreement says otherwise.
• Decision-Making: How are major decisions made? Do you require unanimous consent, majority, or a specific voting threshold? Tip: List out what counts as a major decision, such as raising funds, selling the company, or issuing new shares.
• Dispute Resolution: Does your agreement specify how disputes will be handled (for example, mediation or arbitration)? State caveat: Some states require arbitration clauses to be clear and conspicuous.
• Confidentiality and Non-Compete Clauses: Are there restrictions on founders working for competitors or sharing confidential information? State caveat: California generally does not enforce non-compete agreements, but confidentiality clauses are usually valid.

It is common for founders to overlook these details, especially after the initial excitement of forming a company. However, investors and potential partners will want to see that these issues are addressed before moving forward.

Example: A startup in Delaware is preparing for a Series A round. The investors ask to see the founders agreement and discover that one founder who left early still owns 25 percent of the company with no vesting. The investors insist on a buyback before they will invest, delaying the deal and creating tension among the remaining founders.

How Founders Agreements Fit With Other Startup Documents

A founders agreement is just one part of your startup's legal foundation. It should work alongside your company's other governance documents, such as:

• Operating Agreement (for LLCs): Sets out the rules for running an LLC, including management and profit distribution. State caveat: Many states, including Delaware and New York, require an operating agreement for LLCs, even if it is not filed with the state.
• Bylaws (for corporations): Outline how the corporation is governed, including board structure and shareholder meetings. Tip: Bylaws are required in most states for C-corporations and S-corporations.
• Shareholder Agreements: Address rights and obligations of shareholders, including transfer restrictions and exit strategies. Example: A shareholder agreement may give the company a right of first refusal if a founder wants to sell their shares.
• IP Assignment Agreements: Ensure that all intellectual property created by founders and employees is owned by the company. Tip: Investors will often require signed IP assignments from all founders and key employees before closing a deal.

It is important that your founders agreement does not conflict with these documents. For example, if your operating agreement says all decisions require unanimous consent, but your founders agreement allows for a simple majority, this can cause confusion and legal risk.

Before a new deal or raise, review all your governance documents together. Make sure they are consistent and up to date. If you are unsure, a startup-focused attorney can help you spot conflicts and suggest updates.

Example: A two-founder LLC in Florida has an operating agreement that requires unanimous consent for major decisions, but their founders agreement says a majority is enough. When they disagree on whether to pivot the business, the conflicting documents make it hard to resolve the issue and delay a key partnership opportunity.

Common Mistakes When Drafting or Updating a Founders Agreement

Even experienced founders can make mistakes with their agreements. Some of the most frequent issues include:

• Not Having a Written Agreement: Verbal understandings are rarely enough. Always put your agreement in writing and have all founders sign it. Example: A handshake deal about equity can lead to lawsuits if the company becomes valuable.
• Unclear Equity Splits: Vague or handshake deals about ownership can lead to major disputes later, especially if the company becomes valuable. Tip: Spell out the exact percentage or number of shares each founder owns.
• No Vesting Schedule: Without vesting, a founder who leaves early may keep all their shares, which can discourage future investors and team members. Example: A founder leaves after six months with 40 percent of the company, making it hard to attract new talent.
• Ignoring IP Ownership: Failing to assign IP to the company can result in founders keeping rights to key technology or branding, which can scare off investors. Tip: Use a separate IP assignment agreement to make ownership clear.
• Outdated Roles and Responsibilities: As your company grows, founders' roles may change. Your agreement should reflect current duties and expectations. Example: A founder originally in charge of sales shifts to product, but the agreement is never updated, causing confusion about accountability.
• Missing Exit or Buyout Terms: If a founder leaves, there should be a clear process for buying back their equity at a fair price. State caveat: Some states require a specific formula or process for valuing shares.
• Not Updating After Major Events: Fundraising, new hires, or pivots can all affect your agreement. Review and update it regularly. Tip: Set a calendar reminder to review your agreement at least once a year.
• Conflicting Documents: Having inconsistent terms between your founders agreement and other governance documents can create legal risk and confusion. Example: Your bylaws require board approval for issuing new shares, but your founders agreement says founders can decide by majority vote.

These mistakes can be costly. For example, a founder who leaves with a large equity stake but no ongoing involvement can cause tension and make it harder to raise funds. Investors will look closely at your founders agreement to make sure these risks are addressed.

Checklist: Avoiding Common Mistakes

• Write down all agreements and have all founders sign
• Clearly state equity splits and vesting schedules
• Assign all IP to the company in writing
• Update roles and responsibilities as your company grows
• Include clear exit and buyout terms
• Review and update after major events
• Check for conflicts with other company documents

State Law Issues and Federal Considerations

While there is no federal law requiring a founders agreement, federal rules still affect your business. For example, the IRS requires you to obtain an Employer Identification Number (EIN) for tax purposes, and the Small Business Administration (SBA) offers guidance on choosing a business structure. These federal requirements do not replace the need for a clear founders agreement, but they do set some baseline rules for your company's operations.

State law can have a much bigger impact. Each state has its own rules about business formation, governance, and what must be included in your company documents. For example:

• Delaware: Popular for startups and venture-backed companies. Delaware law is flexible, but you must file a certificate of incorporation and follow specific corporate formalities. Tip: Delaware courts often enforce written agreements between founders, but you must keep your cap table and filings up to date.
• California: Has additional requirements for corporations and LLCs, including annual filings and minimum franchise taxes. State caveat: Non-compete clauses are generally unenforceable in California, but confidentiality and invention assignment clauses are usually valid.
• New York: Requires LLCs to publish a notice of formation in newspapers and file proof with the state. Tip: New York courts may require a clear process for valuing shares in buyouts.
• Texas: Does not require an operating agreement for LLCs, but having one is strongly recommended. Tip: Texas courts will generally enforce written founders agreements if they are clear and signed.
• Florida: Requires corporations to file annual reports and keep records of major decisions. Tip: Make sure your founders agreement is consistent with your bylaws and articles of incorporation.

Check your state's Secretary of State or Division of Corporations for specific requirements. Your founders agreement should not contradict state law or your official company documents. If you are incorporated in Delaware but operate in another state, you may also need to register as a foreign entity and comply with local rules.

Industry-specific regulations, such as those for financial services or healthcare, may also affect what you need in your agreements. Always consider both federal and state rules when drafting or updating your founders agreement.

Example: A fintech startup in California includes a non-compete clause in its founders agreement. When a founder leaves to join a competitor, the company tries to enforce the clause, but California law makes it unenforceable. The company could have protected itself better with a strong confidentiality and non-solicitation clause instead.

Checklist: What To Review Before Signing or Raising Funds

Before you sign a new deal, bring on investors, or start a fundraising round, use this checklist to review your founders agreement:

• Are all founders listed, with accurate names and contact details?
• Is the equity split clearly stated and up to date?
• Does the agreement include a vesting schedule (for example, four years with a one-year cliff)?
• Are roles, titles, and responsibilities clearly defined?
• Is there a process for making major decisions (board votes, unanimous consent, etc.)?
• Does the agreement address what happens if a founder leaves, is terminated, or becomes disabled?
• Are there buyback or repurchase terms for founder equity, and is the process for valuing shares clear?
• Does the agreement assign all IP created by founders to the company?
• Is there a dispute resolution process (mediation, arbitration, etc.)?
• Are confidentiality and non-compete (if enforceable) clauses included?
• Have you reviewed the agreement with your other governance documents to avoid conflicts?
• Are you in compliance with your state's business structure and filing requirements?
• Have all founders signed the agreement, and is it stored in a safe place?
• Do you have a process for updating the agreement after major events?

Practical Tip: Keep a digital and physical copy of your signed agreement, and make sure all founders have access. Review your agreement at least once a year, or whenever there is a major change in your business. If you are preparing for a funding round, investors will expect to see a clear, up-to-date agreement as part of their due diligence process.

Example: A biotech startup in Massachusetts is preparing for a seed round. The investors ask to see the founders agreement and governance documents. Because the founders have kept everything up to date and consistent, the due diligence process goes smoothly and the deal closes quickly.

FAQs

Is a founders agreement legally required?

No federal law requires a founders agreement, but it is highly recommended for any business with more than one founder. Some states may require certain governance documents, especially for corporations and LLCs, but a founders agreement is usually an internal contract. Investors and partners will expect to see one, even if it is not mandatory.

What is the difference between a founders agreement and an operating agreement?

A founders agreement is a contract between the original founders, covering equity, roles, and what happens if someone leaves. An operating agreement is a formal document required for LLCs in many states, outlining how the business is managed, how profits are distributed, and other governance rules. Both are important, but they serve different purposes and should not conflict.

Can we update our founders agreement after forming the company?

Yes, you can and should update your founders agreement as your business evolves. Major events like new hires, fundraising rounds, or changes in roles are good times to review and revise your agreement. Make sure all founders agree to the changes and sign the updated document. Keep both old and new versions for your records.

What happens if a founder leaves before their equity is fully vested?

If your agreement includes a vesting schedule, the departing founder will only keep the portion of equity that has vested up to their departure date. The unvested shares typically return to the company or are subject to a buyback. This is a key protection for the business and remaining founders. The exact process should be spelled out in your agreement and comply with state law.

Do investors require a founders agreement before funding?

Most professional investors, including venture capitalists and angel investors, will expect to see a clear, signed founders agreement as part of their due diligence. They want to know that equity is properly allocated, IP is owned by the company, and there are clear rules for founder departures. A missing or outdated agreement can delay or even kill a deal.

Key Takeaways

• A founders agreement is a practical contract that sets out equity, roles, and what happens if a founder leaves.
• Review and update your agreement before any new deal or fundraising round, and after major business changes.
• Make sure your agreement is consistent with your company's other governance documents and state law requirements.
• Common mistakes include unclear equity splits, missing vesting schedules, failing to address IP ownership, and not updating after major events.
• Use a checklist to review your agreement, and consult with a startup-focused attorney if needed, especially for state-specific issues.

If you are preparing for a new deal, fundraising round, or want to make sure your founders agreement is up to date, our team can help you review your documents and spot potential issues. Reach out at (888) 449-8437 or team@sprintlaw.com to discuss your next steps. Where legal services are required, they are delivered by licensed lawyers at trusted US law firms through the Sprintlaw platform.