Founders Agreement

What Is a Founders Agreement?

A Founders Agreement is a contract between the people who start a business. In Australia, this document sets out the rules for how the founders will work together. It covers who owns what, how decisions get made, and what happens if someone wants to leave. Think of it as a roadmap for the relationship between the business owners.

This document is sometimes called a "pre-nuptial agreement for business". It outlines expectations and protects the company if things go wrong. While it is not mandatory to file this document with ASIC (Australian Securities and Investments Commission), it is a standard practice in the Australian startup ecosystem.

The agreement can cover several things. It defines the equity split between founders. It details the roles each person will play. It also sets up rules for intellectual property (IP) ownership. For tradespeople or small businesses, this document often overlaps with a Partnership Agreement, but it focuses specifically on the initial establishment phase.

Having a written agreement prevents misunderstandings later. If you are building a tech startup, a consulting firm, or a construction business with a partner, this document creates a clear legal foundation.

When to Use This Document

You should use this document as early as possible. The best time to draft it is before you register your company or start accepting money. It is crucial to have the terms settled while the relationship is still positive.

Before Incorporation

Many founders start as an unincorporated partnership. In Australia, state-based laws like the Partnership Act 1895 (WA) (and similar acts in other states) apply to these arrangements. These laws often imply that partners share profits and capital equally unless a written agreement says otherwise. If you do not want a 50/50 split, you need this document to override the default state laws.

During Company Registration

Most founders sign this document at the same time they register their company with ASIC. This helps the company comply with the Corporations Act 2001 (Cth). It ensures that the issue of shares is formal and recorded correctly. It is also the right time to address tax implications, such as Employee Share Scheme (ESS) rules under the Income Tax Assessment Act 1997 (Cth).

Before Hiring or Raising Capital

If you plan to hire staff or seek investment, you need a solid internal structure. Investors will want to see that the founders have a clear plan for decision-making and dispute resolution. It also helps clarify the difference between being a founder and an employee, which is important for compliance with the Fair Work Act.

When Bringing in a New Partner

Sometimes a business starts with one person and brings in a co-founder later. You should use this document whenever the ownership structure changes. It ensures the new partner understands the existing rules and agrees to the same obligations.

Key Sections and Required Elements

A good Founders Agreement covers several specific areas. These sections ensure the business operates smoothly and follows Australian law.

Equity and Vesting

This section determines who owns the company. It should state the percentage of shares each founder holds. However, it should not stop there. Industry practice dictates that equity vests over time. This means founders earn their shares gradually rather than getting them all upfront.

A standard schedule involves vesting over three to four years. This often includes a one-year "cliff". If a founder leaves before the first year, they get nothing. After the cliff, their shares vest monthly. This "reverse vesting" protects the company if a founder leaves early.

You must also define what happens to shares if a founder leaves. Are they a "Good Leaver" or a "Bad Leaver"? A Good Leaver might be someone who leaves due to illness or redundancy. They may keep their shares or sell them back at fair value. A Bad Leaver might be fired for misconduct. They may have to sell their shares back at a discounted price.

Intellectual Property Assignment

This section is vital for tech startups and creative businesses. Under the Copyright Act 1968 (Cth) and the Patents Act 1990 (Cth), IP transfer must be in writing and signed to be legally effective. This clause assigns all IP created by the founders to the company.

It must cover both "past" and "future" IP. Past IP includes work done before the company existed. Future IP covers work done after signing. You should also include a waiver of moral rights where the law permits. This ensures the company owns the product it is building and can use it without restriction.

Roles and Responsibilities

Ambiguity causes conflict. This section outlines what each founder does day-to-day. It should list specific titles, such as CEO or CTO. It should also state the expected time commitment. Is everyone working full-time, or is one founder part-time?

You can include Key Performance Indicators (KPIs) or specific deliverables. This helps hold founders accountable. It clarifies who is responsible for sales, who manages the product, and who handles the finances.

Decision Making and Governance

You need to know how decisions are made. The agreement should define voting rights. A common structure is a 50/50 split, but this creates risks. It should also list "Reserved Matters". These are big decisions that need everyone to agree. Examples include taking on large debts, changing the business model, or issuing new shares.

This section should also set out how often the board will meet and how notices for meetings are sent. This ensures the company follows good governance standards under the Corporations Act.

Dispute Resolution

Disputes happen. A dispute resolution clause provides a roadmap for solving them without going to court immediately. In Australia, there is a strong preference for Alternative Dispute Resolution (ADR). The clause should mandate mediation or negotiation before litigation.

For 50/50 partnerships, you need a "Deadlock Breaker". This is a mechanism to solve stalemates. Common methods include "Russian Roulette" or "Texas Shootout". These rules force a resolution if founders cannot agree, preventing the company from stalling.

How to Write a Founders Agreement (Step by Step)

Writing this document requires careful thought. Follow these steps to create a robust agreement for your Australian business.

Step 1: Discuss the Basics with Your Co-Founders

Sit down and have an honest conversation. Do not leave this step to your lawyer. You need to agree on the big picture first. Discuss who brings what to the table. Talk about how much money everyone is investing. Decide who will be the director.

If you cannot agree on these basics now, a document will not fix the problem later. This discussion often reveals if you and your partners are aligned.

Step 2: Determine the Equity Split

Decide how to divide the ownership. Avoid a simple 50/50 split if possible, or ensure you have strong deadlock provisions. Consider the value of the idea versus the execution. The person writing the code or doing the work usually holds more value than the person with just the idea.

Document the nominal price paid for shares. Ensure this complies with tax laws to avoid issues with the ATO. You might need to use a Share Subscription Agreement alongside your Founders Agreement.

Step 3: Define the Vesting Schedule

Write down the vesting terms. Use the standard four-year period with a one-year cliff. Be specific about the trigger events that cause vesting to accelerate or stop.

Make sure the agreement states clearly that unvested shares are forfeited if a founder leaves. This is a key protection for the remaining founders.

Step 4: Detail the IP Transfer

Draft a clear clause assigning all IP to the company. Use specific language to satisfy the Copyright Act. Ensure all founders sign it.

If a founder has existing IP they want to keep, list it as an exclusion. However, be careful. If the business relies on that excluded IP, you have a problem. It is usually better for the company to own all relevant IP.

Step 5: Set Roles and Decision Rules

Write down who does what. Be specific. "Managing the business" is too vague. "Managing sales and marketing" is better.

Establish the voting rules. Decide which decisions need unanimous consent. These "Reserved Matters" protect minority shareholders from being outvoted on major issues.

Step 6: Plan for the Worst

Include your dispute resolution process. Choose a mediation service or a specific process for deadlock.

Draft the exit terms. Define "Good Leaver" and "Bad Leaver". This will save you a lot of pain if someone leaves. It prevents a founder who leaves after three months from walking away with a huge chunk of the company.

Common Mistakes to Avoid

Many Australian founders make errors that cost them time and money. Here are the most common pitfalls.

Ignoring the 50/50 Deadlock

A 50/50 partnership is the most dangerous structure for a startup. If partners disagree, the company stops. Without a deadlock breaker, you may end up in court. This is a primary cause of startup failure. Always include a mechanism to break a tie, such as a casting vote or a buy-out clause.

Confusing Founders with Employees

Failing to distinguish between a founder and an employee leads to trouble. Just because someone is a founder does not mean they are not an employee. If they work for the company, they need an employment contract. They are entitled to annual leave and superannuation under the Fair Work Act. Do not assume shares are enough compensation for full-time work.

Non-Compliant Share Issuance

You must issue shares formally under the Corporations Act. Verbal agreements or vague promises do not count. You must update the company's register of members. Failure to do so can lead to disputes with the ATO regarding unpaid tax and unpaid capital.

Unclear Tax Treatment

Be careful with share valuation. If you issue shares for less than market value, you may trigger tax under Employee Share Scheme (ESS) rules. The ATO has strict rules about this. Your agreement should clarify if shares are fully paid and non-assessable. If you do not address this, a founder who leaves might face a large tax bill on "discounted" shares.

Legal Considerations (AU)

Australian law imposes specific requirements on Founders Agreements. You must understand these to ensure your document is valid and effective.

Statutory Duties of Directors

If you register a company, the founders who become directors must comply with the Corporations Act 2001 (Cth). Sections 181 to 184 outline these duties. They include the duty to act in good faith and the duty to use your position for a proper purpose.

Your Founders Agreement cannot contract out of these duties. A private agreement cannot stop ASIC from prosecuting a director for breaching their statutory obligations. However, the agreement can define how the company indemnifies founders for costs incurred while acting as a director, within the limits of the law.

Taxation and ESS

The Income Tax Assessment Act 1997 (Cth) governs how shares are taxed. The ATO views discounted shares as income. If you issue shares to a founder for $1 when they are worth $100, the ATO views the $99 difference as taxable income.

You need to determine if your arrangement falls under the Employee Share Scheme rules. Tax Ruling TR 2005/D15 provides guidance on this. Getting this wrong can result in unexpected tax liabilities for your founders.

Intellectual Property Laws

The Copyright Act 1968 (Cth) requires IP assignments to be in writing. A casual conversation about handing over code is not legally binding. You need a signed clause in your agreement.

For patents, the Patents Act 1990 (Cth) has similar requirements. You must ensure the founder who invented the product transfers ownership to the legal entity. Without this, the company cannot enforce its IP rights or sell the business later.

Partnership Laws

If you operate as a partnership before incorporating, state laws apply. For example, the Partnership Act 1895 (WA) implies fiduciary duties between partners. It also dictates liability. In a partnership, partners are often jointly liable for debts.

Your Founders Agreement can modify how you share profits and capital. However, it cannot remove liabilities imposed by state law to third parties, such as banks or customers.

Crowd-sourced Funding Restrictions

If you plan to raise money through equity crowdfunding in the future, you must be careful. The Corporations Amendment (Crowd-sourced Funding) Act 2017 restricts certain share classes. Your Founders Agreement must not contain pre-emption rights or drag-along clauses that conflict with the CSF regime. You should review this if you have plans to list on a crowdfunding platform.

Frequently Asked Questions (preview)

Is a Founders Agreement legally binding in Australia?

Yes, provided it meets the general requirements of a contract. It must have offer, acceptance, consideration, and an intention to create legal relations. For IP transfers, it must be in writing and signed.

Do I need a lawyer to draft this?

While you can use templates, complex startups should seek legal advice. A lawyer can ensure you comply with the Corporations Act, tax laws, and state legislation. They can also tailor the vesting and deadlock clauses to your specific needs.

Can I change the agreement later?

Yes, you can vary the agreement. However, you usually need the unanimous consent of all founders to do so. It is easier to get it right the first time than to renegotiate when relationships are strained.

What is the difference between a Founders Agreement and a Shareholders Agreement?

A Founders Agreement is usually signed early. It focuses on the initial setup and relationship between the creators. A Shareholders Agreement is often signed later when external investors join. It covers broader governance and investor rights. However, the two documents often overlap.

How does the Fair Work Act affect founders?

If a founder performs work for the company, they may be considered an employee. This means they are entitled to the National Employment Standards. This includes minimum wage, annual leave, and superannuation. You should have a separate Employment Agreement for founders who are also employees.