One of the crucial steps to starting a business that many entrepreneurs miss, is a “founder prenup”. Company founders should always sign a contract that governs their business relationships.
The primary reason to enter into a prenup in the context of marriage is to manage expectations and ensure that imbalances in contribution to the marriage are understood and acknowledged in advance. The same applies to founders’ agreements: we want to ensure that the respective contributions of the founders are set out upfront, the business is protected if something goes wrong and there is a predetermined outcome if the founders part ways.
Five reasons why a founders’ prenup is so important
1. Intellectual Property
Any Intellectual Property created by a founder who is not an employee (paid under PAYE) of the company belongs to that founder from the point of creation. To transfer the IP to the company, a written agreement must be signed. Unless the company owns the IP, it may be unable to use it if the founder who created the IP leaves.
Founders usually receive shares as “sweat equity” – compensation for the work they will do for the company. If a founder leaves in the early stages of growth, the remaining shareholders will want to take back some or all of that leaving founder’s shares. Unless there is a written vesting agreement in place (using quite precise language), the shareholders may be unable to take back these shares – meaning that a person no longer involved in the business retains significant shareholding and will benefit from the hard work of the remaining shareholders.
It’s important that a founder is unable to set up a competing business or use the skills and know-how they gained working for a company to benefit another company. You always want to make sure there are written restrictive covenants in place with each co-founder to ensure that they can’t damage the company by setting up or working for a competing business.
4. Managing Expectations
Founder relationships most commonly go wrong because there is a mismatch in terms of the founders’ understanding of their roles, the required time commitment and the timeframe for the business to generate significant funds. Setting out a business plan and expected contributions at the start helps to avoid these kinds of problems.
5. Maintaining Confidentiality
Nobody needs dirty laundry to be aired in public. Founders should agree to written confidentiality provisions ensuring that trade secrets relating to the business and details of any disputes cannot be disclosed outside of the company. This protects the company’s business secrets from being disclosed to competitors and reduces the risk of reputational harm if founders fall out.
Buckworths is the only law firm in the UK working exclusively with start-ups and high growth businesses. With 70% of its clients in technology, of which half are fin-tech businesses, the firm is recognised for its unparalleled expertise in advising start-ups from incorporation, to strategically raising investment, to exit. It has a finger on the pulse of the start-up ecosystem, and offers clients a clear understanding of current market trends.