One of the biggest mistakes I see new entrepreneurs make is not setting up a solid foundation for success between themselves and their partners or cofounders when they start building their business in the form of a shareholders’ or partnership agreement. Now, just in case you’re new to my blog, I am not a lawyer so I cannot give you legal advice. But I have seen many an entrepreneur stuck with ulcers and migraines because they didn’t have an agreement in place from the beginning and then the relationship with his or her cofounders fell apart. In order to make sure that the new business is on sound footing and that you won’t be in hot water when the going gets tough you absolutely have to have a few items spelled out in a formal legal document before jumping in.
When it’s just you and your cofounders high on startup euphoria and loving life and loving each other, it seems like nothing could ever go wrong, but I guarantee there will be disagreements and the road will get a bit rockier down the line, so having a document that clearly spells everything out will save you from a potential nightmare.
In your agreement make sure that you clearly spell out the following:
- First, you need to identify who contributed what – This includes everything from office space to computers or equipment to actual cash. If anyone chipped in, you should identify who it was and what they added.
- Next, you need to say who owns what – Not all companies are split up exactly in line with the monetary contributions each person made. You need to be clear in your document about who owns how much of the company
- Along those same lines, you need to say when they own that much. It’s in everyone’s best interest to set up a vesting schedule for anyone whose contributions that earn him or her equity are non-monetary. If you don’t, you run the risk of someone signing on as a key contributor but then walking away with his or chunk of equity and not actually adding any value. If you create a vesting schedule and someone turns out to be a total slacker, you’re not stuck handing over part of your company anyway. Be clear about what they have to do to vest, when they vest, and what would give you grounds to kick them out without allowing them to vest.
- You also need to identify who controls what – and this is on a few different levels…The first bit of this relates to voting rights and classes of stock. Just because I own 50% of the stock of a company does not mean I necessarily have a 50% say in what that company can do. There are numerous ways of structuring ownership and control so that they are not necessarily directly in line. Look at examples like Zuckerberg’s control of Facebook. The next bit relates to decision making outside of the most major company decisions and you need to decide who is allowed to make what type of calls for the company – i.e., who can sign contracts, who can take on debt, who can spend money, etc. It’s normal to set limits on what certain team members can do or spend – for example, cofounder A is allowed to spend up to $500 without talking to the others but anything over that amount requires a vote. You need to clearly define which decisions can be made unilaterally, by who, and which need agreement. Then you want to be clear about how any of these decisions that need consensus are made and what percentage of the votes are required to make it happen.
- Next up, you need to identify who is responsible for what. This will probably tie in closely with both the vesting schedule and the discussion about decision making power. If you’re bringing team members in to help you build your business and sharing equity with them, it needs to be clear what their roles are and what they are responsible for so everyone is clear on who is in charge of what.
- Finally you need to discuss the possibility of someone departing from the company, and that means whether they leave on good terms, bad terms, or perhaps even pass away. What are all of the shareholders’ rights when it comes to selling or transferring ownership, what are their rights in terms of transferring power, and what happens to their ownership and control if they die.
It can seem stressful and be a bit uncomfortable to hash all of this out when you’re at the very beginning stages of your business, but if you don’t do it now, it will almost certainly come back to bite you in the butt. Put in the necessary time and energy so that your business has a solid foundation and you and your cofounders can move forward with everyone on the same page.
Now I’d like to hear from you. Do you have a story of when not having a shareholder or partnership agreement screwed you or when having one saved you? What other important elements do you think should be in an agreement of this kind? Let us know in the comments below and, if you found this video helpful or you think someone you know would be interested, please spread the love by liking and sharing it.