The Power of a Well-Drafted Founders’ Agreement
The startup world is highly dynamic and involves a lot of moving pieces to make them work. In that dynamic world, a well-crafted founders’ agreement often makes the difference between sustained success and a fractured vision. The founders agreement is a Foundation document which establishes the operational framework for how co-founders collaborate, manage equity, reward employee hard work and loyalty, and navigate potential conflicts amongst themselves should same arise during their operations.
For fintech startups, the stakes are even higher. FinTech startups have to navigate very complex regulatory landscapes, reliance on intellectual property, and a rapidly evolving market, so a comprehensive founders’ agreement becomes essential to safeguarding their future. You should note that this Agreement is not just about protecting the startup; it is also about ensuring that each founder’s contributions to the startup and their expectations are clearly defined, leaving no room for future guesswork.
In this article, we’ll explore the critical components of a founders’ agreement, the unique challenges fintech startups face, and why having a tailored agreement can help them navigate the business terrain on solid ground.
Key Components of a Comprehensive Founders’ Agreement
Before your legal team commences work to draft your FinTech startup’s Agreement, it is important they run through a couple of key components they will include in the proposed Agreement with you [and your co-founders] because these clauses are very important. We will highlight them below:
Company Purpose and Objectives:
It is very important for the founders of a startup to carefully and comprehensively highlight the purpose for which they are setting up the startup. What are its objectives? What problems does it aim to solve? Given that the startup will be public-facing as a fintech startup, what specific functions will it be carrying out? Setting out company goals clearly will ensure that all founders agree on what they are getting into. Furthermore, since most founders prepare and sign their Founders’ Agreements before registering their startup as a company [or other entity formation type in the jurisdiction they plan to operate, the objectives they outline in their Agreement will form the objectives they outline in their incorporation articles when they register their company.
Capital Contributions and Funding
This section in the Agreement should extensively detail the contributions of the founders to the startup. Are they contributing finances, assets [office space, car, etc], technical expertise or services to the startup? They should also highlight room for future funding rounds from interested investment partners down the line. Doing these will prevent disputes down the line. In case of future disputes as well, the founders can fall back to their initial founders agreement for the clause that outlines the capital contribution of each founder.
The agreement should explicitly detail:
Amount of Contribution: What is the specific monetary or in-kind value each founder will contribute to the startup? It could be actual cash, existing assets (like software, office space or equipment), or intellectual property. Highlight what each founder will contribute to the startup.
Timing of Contribution: The Agreement should be clear on establishing a timeline for when each founder is required to make their capital contribution to the success of their venture. This will surely prevent delays in launching operations so the founders are not held back by a reluctant founder or one who is dragging their feet.
Equity Allocation: It is important for you to set down how the initial equity ownership of each founder will be in the startup when you launch based on each founder’s contributions. In Nigeria, you can use this to set up the shareholding percentage of each founder in the company you incorporate for your startup operations. Often, this is proportional to the capital each founder invests, but it is not always the case. You should also acknowledge that non-monetary contributions will justify equity allocation if what the founder is bringing to the table helps to propel operations for the startup.
Future Funding and Dilution: When drafting the founders agreement, you should anticipate future funding needs of the company and immediately address the possibility that the founders’ shares will be diluted when this happens. In these subsequent funding rounds, it is possible you will raise capital from external investors. In such cases, the founders can retain their pre-emptive rights which allows them the option to maintain their proportionate ownership by participating in future funding rounds before the company brings in new investors. That way, founders can prevent excessive dilution of their shares.
Intellectual Property and Technical Know-How
In today’s knowledge economy, intellectual property assets are as important as physical assets, sometimes, even more so. Founders should ensure that the startup owns all the IP created as the startup works to attain its objectives. Softwares created, scripts, tech stacks, among others, should be assigned to the company. The founders agreement should have clauses that stipulates the agreement of all the founders to assign their IP created as they work on the startup, to the startup. This will particularly be important in case of founder exits from the company in the future.
Vesting Schedule for Founders’ Shares
Founders may decide to have all their shares allocated to them immediately upon registration of the company. However, with this approach, there is a risk some founders might exit quickly from the startup, especially if it becomes very profitable in a short time or the startup gets huge funding, thus making the founders “richer”. By creating a vesting schedule for the founders if and when they meet certain performance or time metrics, they can mitigate the risk of early exits by co-founders from the startup.
Exit Strategy and Buyback Mechanisms
An exit strategy is an essential part of any founders’ agreement, as this ensures that the company can handle a founder’s departure without jeopardizing operational stability. Paired with buyback mechanisms, these clauses provide a clear roadmap for managing equity in the event of an exit, protecting both the remaining founders and the business.
Why Exit Strategies Matter and its key components
Founders leave for various reasons—career changes, personal challenges, or even conflicts within the team. If the founders lack a structured exit plan, such departures can lead to disputes, create operational bottlenecks, or leave significant equity in the hands of an inactive founder or one whose values no longer aligns with that of the other members of the team. Exit strategies define the steps to follow, reducing the risk of prolonged conflicts and uncertainty.
It is also important for the founders to define the circumstances under which an exit strategy will be triggered for a founder. Instances include voluntary resignation, incapacity, death, termination for cause. Whatever the instance that triggers an exit strategy, it is important that the founders agreement should specify how to value the departing founder’s shares; this can be by determining its fair market value [FMV] as determined by an independent valuator, or a pre-agreed formula which the founders may tie to company revenue or company milestones.
Reallocation of Unvested Shares: If a founder leaves before their shares are fully vested, the unvested portion typically reverts to the company. These shares can then be redistributed to attract new talent or secure additional investment. Conversely, the founders may decide to sell the shares to the departing founder, or even trigger a mandatory sale of already vested shares, requiring the departing founder to sell a portion or even all of their vested shares back to the company.
Founders Compensation
A well-defined compensation structure ensures clarity and fairness in how founders and management get remunerated. It sets expectations early, detailing salaries, bonuses, and other benefits while accounting for the company’s financial health. Founders often agree to modest salaries initially, tying significant compensation to the company’s performance or milestones achieved. Transparent agreements on raises, bonuses, or profit-sharing will eliminate misunderstandings between the founders as the business grows and funds start coming in.
Employee Equity Plan
An employee equity plan helps attract and retain top talent by offering stock options as part of their compensation. Startups often face resource constraints, and equity serves as a powerful incentive for employees to invest in the company’s success. Offering clear terms for vesting, exercise rights, and the potential for financial rewards aligns employee interests with the company’s long-term goals. This approach motivates team members to commit to the company’s vision while fostering a sense of ownership and loyalty.
Common Mistakes to Avoid When Drafting Founders’ Agreements
A well-drafted founders’ agreement is the bedrock of a successful startup. However, several common pitfalls can undermine its effectiveness, leading to disputes and complications down the road. Here are some critical mistakes to avoid:
Failing to Include a Vesting Schedule:
Without a vesting schedule, a founder could leave shortly after the company’s inception, taking their full equity stake with them, even if they contributed minimally to the company. That way, they get to attain full benefits from the company as the company makes profit, gets funding and valuation, et cetera. A vesting schedule is thus very essential, as it will incentivize long-term commitment from the founders to the cause of the startup and for them to stay and commit to its growth.
Mistake to Avoid: Not including a vesting schedule at all, or using a vesting schedule that is too short or too lenient on a co-founder in relation to their equity stake in the company.
Overlooking IP Assignment Clauses:
Intellectual property (IP) is often a startup’s most valuable asset, especially in the tech and fintech industries. Without clear IP assignment clauses in the founders agreement, the founders can dispute ownership of critical IP in the future, or in case of disputes amongst themselves, and this can create very significant problems for the company.
Mistake to Avoid: Using vague language, not covering all types of IP (patents, trademarks, copyrights, trade secrets), or not including clauses for IP developed before the company’s formation but related to its business, or IP developed before the company’s formation but developed in anticipation of the company’s operations.
Lack of Clarity on Exit Strategies or Founder Removal:
The founders’ agreement should address potential exit scenarios (e.g., acquisition, IPO, sale to another company) and the circumstances under which a founder can be removed from the company. Without clear provisions, founders can battle over these during very critical times in the company’s life span. So, it is important that the Agreement specifies these issues, and even include “Bad Leaver” Clauses which are clauses that specify what happens to a founder’s equity if they leave the company under negative circumstances (e.g., termination for cause). Typically, they will forfeit some or all of their unvested (and sometimes even vested) equity.
Mistake to Avoid: Not addressing exit strategies at all, using ambiguous language regarding founder removal, or not including “bad leaver” provisions.
Ignoring Potential Regulatory Compliance Issues in the Fintech Space:
Fintech is a heavily regulated industry, and cross-border fintech ventures face even more complex regulatory landscapes. The founders’ agreement must consider these regulations and ensure the company’s operations comply with all applicable laws and regulations in the space. Anything otherwise will be a recipe for disaster.
Mistake to Avoid: Not consulting with legal counsel specializing in fintech regulations in the relevant jurisdictions, or not including clauses in the agreement that address compliance requirements which the founders must fulfill when they incorporate their company and prepare to commence operations.
If founders avoid these common mistakes, startups can create a robust founders’ agreement that protects their interests, protects the interest of the startup itself, and helps them set the stage for long-term success.
If you are a founder and have any questions, we have an experienced legal team which specializes in helping entrepreneurs across the African startup ecosystem navigate the complexities of startup creation, development and cross-border ventures. Please contact us on corporateservices@kabbizlegal.com for any inquiries regarding our startup advisory services.
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