As a startup founder, laying the groundwork for a successful business requires more than just a great idea and hard work. One critical element is having a solid legal foundation, starting with a well-drafted founders' agreement. The Founders' Agreement outlines the rights, responsibilities, and obligations of each founder, helping to prevent conflicts and protect your interests.
In Malaysia, a comprehensive founders' agreement is essential to ensure clarity and alignment among co-founders. As a lawyer, I advise that founders' agreements cover key provisions such as equity distribution, vesting schedules, decision-making processes, and dispute resolution mechanisms.
Why a Founders' Agreement is Important?
A founders' agreement acts as a roadmap for the startup’s future. It is crucial for the following reasons:
1. Clarity and Alignment
It sets clear expectations for each founder's role and contributions, ensuring that everyone is on the same page regarding the company's vision and goals.
2. Conflict Prevention
By specifying how decisions are made and how disputes are resolved, the agreement minimises the risk of misunderstandings and disputes.
3. Legal Protection
It formalises the founders' relationships, providing a legal basis for handling various business scenarios, including a founder’s departure or the introduction of new investors.
4. Investor Assurance
Investors often require a founders' agreement as part of their due diligence process, knowing that it demonstrates foresight and structured governance.
Key Provisions in a Founders' Agreement
Equity Distribution
Percentage Ownership: Clearly outline the percentage of ownership each founder holds. This distribution can be based on initial investment, experience, and the role each founder plays in the startup.
Future Equity Issuance: Include provisions for how additional shares will be issued, either to new founders, employees, or investors. This helps prevent dilution of existing founders' equity without mutual agreement.
Vesting Schedules
Vesting schedules ensure that founders remain committed to the startup for the long term. A typical vesting schedule includes:
Cliff Period: A common practice is to have a one-year cliff period, during which no equity vests. After this period, a portion of the equity vests, and the remainder vests over time.
Vesting Period: Usually set between three to four years, vesting schedules align founder interests with the startup’s long-term success.
Acceleration Clauses: Provisions that allow for accelerated vesting in specific events, such as the sale of the company or involuntary removal of a founder without cause.
Roles and Responsibilities
Defined Job Titles and Functions: Specify the roles each founder will play (e.g., CEO, CTO, COO) and their specific responsibilities. This helps in avoiding overlaps and confusion.
Authority Levels: Clarify the decision-making authority of each founder, particularly in key areas like finance, hiring, product development, and partnerships.
Decision-Making Processes
Clearly defined decision-making processes are vital for operational efficiency:
Voting Rights: Establish whether decisions will be made by majority vote, unanimous consent, or through a designated decision-maker.
Approval Requirements: Identify decisions that require the consent of all founders, such as major financial transactions, changes to the business model, or new equity issuance.
Deadlock Resolution: Include mechanisms for resolving deadlocks, such as appointing a mediator or seeking arbitration.
Dispute Resolution Mechanisms
To manage conflicts effectively, a founders' agreement should include:
Negotiation and Mediation: Encourage initial attempts to resolve disputes amicably through negotiation or mediation.
Arbitration: Define arbitration as a method of resolving disputes, specifying the rules, selection of arbitrators, and location. Arbitration can provide a quicker and more cost-effective solution compared to litigation.
Governing Law: Clearly state that the agreement is governed by Malaysian law, which is crucial for startups operating in Malaysia.
Exit Strategies and Founder Departure
Buyout Clauses: Outline terms for buying out a departing founder’s shares, including how the shares will be valued and payment terms.
Non-Compete and Non-Solicitation: Include restrictions on starting competing businesses or soliciting employees or clients for a specific period.
Right of First Refusal: If a founder wishes to sell their shares, this clause gives the remaining founders or the company the first option to purchase those shares.
Intellectual Property (IP) Ownership
Intellectual property is often the most valuable asset of a startup. The agreement should clearly define:
IP Assignment: All intellectual property created by the founders related to the business should be owned by the company. Founders should agree to assign their IP rights to the company.
Confidentiality Obligations: Founders must commit to maintaining the confidentiality of the company's information and not disclosing proprietary details to third parties.
Conclusion
A founders' agreement is an indispensable tool for Malaysian startups, providing a clear framework for managing relationships, decision-making, and potential disputes. By addressing key issues such as equity distribution, vesting, roles and responsibilities, and dispute resolution, founders can lay a solid foundation for their startup's success.
We recommend that founders seek professional legal guidance to draft a tailored founders' agreement that meets the unique needs of their startup. This ensures that all potential issues are anticipated and addressed, providing peace of mind and legal protection as the business grows.
Should you have any questions related to the article above, please do not hesitate to contact our managing partner, Eugene Yeong for clarification.