Why your company needs a founders' contract (inc. a lawyer-drafted template)

What is a founders' contract?

A founders' contract, or shareholders agreement being founding shareholders, is a legal document that outlines the rights, responsibilities and obligations of each founding shareholder in a company. It serves as a blueprint for how the company will operate and how decisions will be made. This type of agreement covers a range of aspects, from decision-making processes, dispute resolution mechanisms and exit strategies.

Why is a founders' contract so important?

1. Prevents disputes

Disputes among founding shareholders can be detrimental to a startup. A well-drafted founders' contract includes provisions for conflict resolution, ensuring that disagreements are handled constructively. This can involve mediation, arbitration, or other dispute resolution methods. By having these mechanisms in place, founders can resolve issues amicably without disrupting the business.

2. Protects equity and ownership

Equity distribution is a critical aspect of any startup. The founders' contract outlines how many shares each founding shareholder holds and the conditions under which equity can be diluted or transferred. This protects the interests of all founders and prevents scenarios where one founder might unfairly lose their stake in the company.

3. Establishes decision-making protocols

Effective decision-making is vital for a startup’s success. The founders' contract sets out the procedures for making major business decisions, such as raising capital, expanding operations, or selling the company. It defines the voting rights of each founding shareholder and the threshold required for different types of decisions, ensuring that everyone has a say in the company’s direction.

4. Provides for future growth and exit strategies

As the company grows, the founding shareholders’ roles and the business landscape may evolve. A founders' contract anticipates these changes and includes provisions for future financing rounds, the introduction of new shareholders and potential exits. It also outlines the terms under which a founder can leave the company, ensuring a smooth transition and minimising disruption.

Key things to include in a founders' contract

To be effective, a founders' contract should address several key areas, including:

1. Shareholder and director’s powers

A founders' contract (being the shareholders' agreement between founding shareholders) should set out the decision-making process for the company, including voting rights for shareholders, the quorum required for meetings, and the frequency of those meetings. It also defines the authority of the board of directors and outlines the procedures for appointing and removing directors. Clearly setting out these matters avoids any ambiguity over the power split between shareholders and directors.

2. Reserved matters

Reserved matters are those decisions or actions that require the approval or consent of the shareholders of a company - sometimes a certain percentage of the shareholders must give their consent or a specific class of shareholders has to approve the decision. It is important to include provisions relating to reserved matters in a founders' contract to provide a level of control and protection for the founding shareholders over important decisions and actions that could significantly impact the company's operations, finances, or even ownership structure. Examples of reserved matters that can require shareholder approval include: appointing auditors, entering into unusual transactions or agreements, amending the company’s articles, matters relating to the capital of the company and lots more!

3. Payment of dividends

A clause should be included that outlines the procedures for distributing profits or dividends to shareholders. The clause should specify how and when the company will distribute profits (via dividends) to the founding shareholders. It will set out how dividends will be calculated so that there is a clear process in place e.g. whether it will be based on profits or other financial metrics. A dividends clause is an important aspect of an agreement between shareholders as it provides clarity and transparency regarding how the company plans to distribute profits to its shareholders. It also helps to avoid any misunderstandings or disputes among shareholders regarding the payment of dividends in the future.

4. Selling shares

The procedure for the founding shareholders to transfer or sell shares should be clearly set out in the founders' contract, so that the founding shareholders know when and how they can exit (if they want to in the future). Where shares are being sold, it is vital to have procedures in place in relation to those shares. For example, pre-emption rights, also known as rights of first refusal, are also often included in a founders' contract to give the existing shareholders the right to purchase any shares that another shareholder plans to sell. The purpose of pre-emption rights is to ensure that the existing shareholders have the opportunity to maintain their proportional ownership in the company and to prevent unwanted (or unknown) third parties from becoming shareholders and therefore diluting the existing shareholders' powers and rights. More information about pre-emption rights can be found here.

5. Restrictions on shareholders

For a founders' contract to have maximum impact, it should set out what the founding shareholders can and cannot do. This can include non-compete provisions and restrictions on selling shares to outside parties. These are sometimes known as “restrictive covenants” and can help protect the interests of the other shareholders. For example, they can prevent exiting shareholders from soliciting employees from a company after they leave, and taking client information to set up a competing business.

Find out more about the key clauses to include in a founding shareholders’ agreement here.

How can Docue help?

A founders' contract is more than just a legal formality; it’s a strategic tool that can significantly influence the success of your startup. By clearly defining roles, responsibilities, and processes, it helps prevent conflicts, protect equity, and ensure smooth decision-making. For any UK startup, investing time and effort into crafting a comprehensive founders contract is a crucial step towards building a robust and resilient business foundation.

With Docue, you can easily prepare a bespoke founders' contract that is customised to your needs. Our cutting-edge technology combined with our lawyer-made founders' agreement template allows you to create, customise, e-sign, store and manage your founders' contract all in one place with just a few clicks. Our lawyer-crafted guidelines provide straightforward support to guide you through every stage of the drafting process.

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