Founders are often fuelled by passion, vision and the drive to create something impactful. However, even the best teams need to get their first actions right.
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Success in the startup world depends on several key factors: a compelling idea, strong product-market fit, access to funding, operational excellence and a scalable business model, among others. While these elements are crucial, they cannot compensate for a weak foundation. At the core of every successful startup lies a well-balanced team of co-founders who trust each other, complement each other’s strengths, share a common vision and can navigate the high-pressure world of entrepreneurship together. Founders are often fuelled by passion, vision and the drive to create something impactful. However, even the best teams need to get their first actions right. These actions include establishing a robust founders’ agreement and ensuring a fair equity distribution. Missteps in these areas can lead to conflicts, instability and even the failure of the venture. Quite often, amidst the excitement, many founders overlook these two critical elements that can make or break their startup.
The Founders’ Agreement: A Blueprint for Stable Relationships
One critical step is to formalise the relationships with a founders’ agreement. Think of it as a prenuptial agreement for business partners. Though not a statutory requirement, it is a legally binding contractual agreement and is essential to prevent misunderstandings during tough times and ensure long-term stability. Formalising founders’ relationships involves candid discussions on a range of issues that eventually impact their long-term journey together. While it may seem unnecessary or even uncomfortable to discuss at the early stages, it is one of the most important steps founders can take to protect their relationship and the future of the venture. Forging an agreement between all founders helps mitigate the risk of costly, time-consuming and painful litigation due to disagreements in the future. As the venture grows and adds new stakeholders, this agreement becomes increasingly comprehensive and vital for stability and survival.
Why is a Founders’ Agreement Necessary?
1. Clarity on Roles and Responsibilities
In the early days of a startup, everyone wears multiple hats. However, as the business grows, ambiguity about who does what can lead to confusion, inefficiency, and even resentment. A founders’ agreement clearly defines each founder’s role, whether handling operations, finance, marketing, or technology. This clarity ensures accountability and prevents overlaps or gaps in responsibilities.
2. Conflict Resolution Mechanism
Disagreements among founders are inevitable. Whether they pertain to the direction of the business, financial decisions, or day-to-day operations, conflicts can quickly escalate if there’s no framework to address them. A founders’ agreement includes a dispute resolution mechanism, such as mediation or arbitration, to handle disagreements professionally and amicably.
3. Protection of Intellectual Property (IP)
Startups often rely on intellectual property, such as patents, trademarks, or proprietary technology. A founders’ agreement ensures that all IP created by the founders is owned by the company, not individuals, and protects future IP created in the company. This agreement also protects the business from potential legal battles if a founder leaves or claims ownership of the IP.
4. Exit Strategy
No one likes to think about failure or a founder leaving, but it is a reality that must be addressed. A founders’ agreement outlines what happens if a founder decides to exit, becomes incapacitated or passes away. It includes provisions for buyouts, vesting schedules and the transfer of shares, ensuring that the business can continue without disruption.
In addition to the above aspects, a comprehensive founders’ agreement covers a host of other issues such as business objectives and long-term goals of the company, equity ownership structure between the founders, commercial terms for founders beyond equity ownership, confidentiality and non-disclosure to protect business information, indemnification from falsehood to protect individual founders, disclosure of conflicts, non-compete and non-solicit provisions, jurisdiction of law provisions, winding up and dissolution provisions should a situation arises and so on.
Also read: Sector-specific funds: The right fit for early-stage founders
Equity Distribution: Getting It Right
Equity distribution is one of the most critical—and often contentious—decisions among founders. While an equal split may seem fair, it is not always the right approach. Equity allocation should reflect each founder’s contribution, commitment, and risk-taking ability.
What are the guiding factors for equity distribution?
Some key factors that could guide a fair equity distribution structure:
1. Commitment and Risk-taking Ability: Founders who commit full-time from the beginning should typically receive more equity than those joining later or working part-time. Timing matters as early-stage risk is higher than post-product-market fit.
2. Risk Reduction Ability: The ability to reduce key risks (technical, commercial, operational, or financial) should be rewarded. If a particular founder’s departure would severely harm fundraising, product development, or business continuity, their role should be weighted accordingly in equity distribution.
3. Contribution in Cash or Kind: Founders who contribute pre-existing IP, capital, or infrastructure (such as office space, equipment, or technology) deserve additional equity. These contributions provide direct advantages to the startup, reducing costs or accelerating development.
4. Market Salary: If one or more founders receive a salary comparable to their prospects in the job market, their equity share should be adjusted accordingly to ensure fairness, granting more equity to those taking lower or no salary.
5. Expertise and Milestones: Some founders bring unique expertise which enhances the probability of the startup’s survival and success (e.g., a serial entrepreneur with strong investor connections). Others achieve critical milestones (e.g., securing a key partnership), justifying higher equity allocations.
Vesting: Protecting the Startup’s Future
Equity should be vested over time to prevent issues with early founder exits (meaning founders earn their equity in pre-decided increments over time). Standard vesting schedules span four to five years, with a one-year cliff (meaning a founder who leaves within the first year gets nothing). Vesting aligns incentives with the long-term success of the venture and ensures that various stakeholders of the startup do not have to bear the burden of ‘dead equity’, i.e. stock owned by individuals and entities no longer contributing to the company.
Where to Begin
1. Getting the Team Right
At the core of every successful startup lies a well-balanced team of co-founders who trust each other, complement each other’s strengths, share a common vision and can navigate the high-pressure world of entrepreneurship together. Many investors prioritise the team over the idea itself, knowing that a strong team can pivot and adapt as needed, while a weak one may falter despite having a great concept. Most investors would bet on the jockey if asked to choose between the horse and the jockey. Several factors, like competence, compatibility, complementarity, chemistry and shared vision, are important in building a strong founding team.
2. Start Early
It is important to establish the founders’ agreement as the first legal document and not wait until conflicts arise or the business gains traction. It is easier to address founders’ relationship issues at the outset when everyone is aligned and motivated.
3. Seek Professional Help
While it is tempting to draft these documents yourself, it is worth investing in legal and financial advice. A lawyer can help you create a comprehensive founders’ agreement, while a financial advisor can guide you on equity distribution.
4. Be Transparent and Honest
A strong founding team should be able to have open and honest conversations about roles, contributions and expectations. Transparency at this stage can prevent misunderstandings later.
5. Revisit and Revise
As the venture evolves, so should the founders’ agreement and equity plan. These documents should be regularly reviewed and updated to reflect changes in roles, contributions or business goals.
Conclusion: Building to Last
Choosing co-founders is one of the most critical decisions an entrepreneur will make. The right founding team, built on certain core principles, significantly increases a startup’s chances of success. However, even the best teams need structure. A well-drafted founders’ agreement minimises risks, prevents disputes and provides a clear roadmap for long-term collaboration. When it comes to equity, careful allocation – based on risk, contribution and commitment – ensures fairness while protecting the company’s future. The startup journey is unpredictable, but founders can build ventures that stand the test of time with the right partners and legal safeguards.
Poyni Bhatt is a Startup Advisor and former CEO of SINE, IIT Bombay.
Rohan Chinchwadkar is an Assistant Professor of Finance and Entrepreneurship at IIT Bombay.
[This article has been reproduced with permission from Indian Institute of Technology Bombay, Mumbai]
