Why every startup should have a founders' agreement

12 July 20266 min readFounders

Founder disputes are not caused by bad faith nearly as often as founders expect. They are caused by two people who agreed enthusiastically about something they never actually defined, discovering eighteen months later that they had understood it differently. The agreement's real function is not to constrain anyone; it is to force the conversation while everyone still likes each other.

What happens if you never sign one

Nothing, until something does. Then the relationship is governed by the Companies Act, 2013 and by the articles of association, and neither provides:

• any link between equity and continued contribution;
• any agreed method for valuing the shares of a founder who leaves;
• any obligation on a departing founder to sell, or any right in the others to buy;
• any way to break a deadlock between two shareholders holding fifty per cent each;
• any clarity about who owns intellectual property created before the company existed.

The practical result is familiar. A co-founder leaves early, keeps thirty per cent of the company, contributes nothing further, and remains on the cap table when an investor looks at it two years later. There is no legal mechanism to undo it, and the negotiation to buy them out happens entirely on their terms.

Vesting: the clause that justifies the document

Vesting ties equity to time and continued involvement. The common shape is four years with a one-year cliff: nothing vests until the first anniversary, at which point a quarter vests, and the remainder vests monthly or quarterly thereafter.

How it is actually implemented in India

In an Indian private company, founder shares are typically issued at incorporation rather than granted progressively. So vesting is usually built in reverse: the founder holds the full allotment from the start, and the company or the continuing founders hold a contractual right to buy back, or to require transfer of, the unvested portion at a nominal or pre-agreed price if the founder ceases to be involved before the schedule completes.

That mechanism has to be drafted with the company law position in mind — a buy-back by the company is a regulated act with its own conditions and limits, and a transfer obligation running to the other founders is often the cleaner route. This is one of the places where a template downloaded from elsewhere tends to fail, because the mechanics assumed by a US-style document do not map onto the Indian statutory scheme.

Define the trigger properly

Vesting stops on a defined event, and the definition does real work. Good cause and bad cause should be distinguished: a founder dismissed for misconduct and a founder who leaves because of illness are not in the same position, and a single undifferentiated "ceases to be involved" trigger treats them identically. Similarly, if an acquisition is a realistic prospect, decide now whether vesting accelerates on a change of control, in whole or in part.

Why the articles matter as much as the agreement

This is the technical point that most founders are not told, and it changes the value of everything else in the document.

A private company is one whose articles restrict the right to transfer its shares. Where restrictions on transfer — rights of first refusal, pre-emption, tag-along and drag-along rights, the buy-back mechanics that implement vesting — are incorporated into the articles, they are on much stronger ground. Where they sit only in a shareholders' agreement, the position is weaker: the proviso to Section 58(2) of the Companies Act, 2013 recognises that a contract or arrangement between shareholders in respect of the transfer of securities is enforceable as a contract, but enforcing a contract against a departing founder after the fact is a materially different proposition from a restriction the company itself is bound to observe.

Whatever the founders agree about shares should be written into the articles, not merely into an agreement kept alongside them.

In practice this means the founders' agreement and an amendment to the articles are one piece of work, done together. Doing the first without the second is the most common defect I see in documents founders have already signed.

What the agreement should cover

Equity and contribution

The split, and what each founder is giving for it — capital, time, intellectual property, a customer relationship. Where the contributions are genuinely unequal in kind, say so; an undocumented assumption that one founder's contribution is capital and another's is time is a reliable source of later disagreement.

Roles, time commitment and outside activity

Who is responsible for what, whether the commitment is full-time, and what other work each founder may keep. "Full-time" means different things to people with a consulting practice they have not quite wound down.

Decision-making and deadlock

Which decisions the founders take jointly, and what happens if they cannot agree. Two equal shareholders with no tie-breaker produces a company that cannot act. Mechanisms range from a casting vote on defined matters, to a neutral third director, to a buy-sell provision in which one founder names a price and the other chooses whether to buy or sell at it.

Intellectual property

Everything created for the business, including work done before the company was incorporated, should be expressly assigned to it. Pre-incorporation work is the gap most often missed — the prototype built over a weekend before there was an entity to own it.

Confidentiality and non-solicitation

Enforceable, and worth having. A post-termination non-compete is a different matter: Section 27 of the Indian Contract Act, 1872 makes agreements in restraint of trade void, and Indian courts have generally declined to enforce restraints operating after the relationship ends. Drafting one anyway gives comfort that will not survive contact with a court.

Exit, transfer and valuation

What a founder may do with their shares, who has the right to buy them first, how they are valued, and over what period the price is paid. An agreed valuation method — even a rough one — is worth considerably more than the fair price that neither side can agree on later.

Death, incapacity and inheritance

Rarely discussed, and awkward when it arises. Without provision, a founder's shares pass under succession law to people who have no involvement in the business and no wish to be there.

Four mistakes worth avoiding

1. Using a foreign template unchanged. The mechanics of US founder vesting rest on a different corporate law scheme. The concepts translate; the machinery frequently does not.
2. Signing the agreement and never amending the articles. Covered above, and the most consequential of the four.
3. Leaving the equity split "to be decided". It never gets easier, and each month of ambiguity raises the stakes of settling it.
4. Treating it as a one-time document. It should be revisited when a founder's role changes materially, when someone joins or leaves, and before a funding round, where it will in any event be replaced or subsumed by the investor's documentation.

When to do it

At incorporation, or as close to it as you can manage. The cost of the document does not change over time, but the difficulty of negotiating it rises with every month of accrued expectation — and it becomes hardest at precisely the moment it is most needed, which is when someone has already decided to leave.