Founders’ Agreements
A Critical Start for a Start-Up
By Naina Krishna Murthy
Managing Partner
Krishnamurthy & Co.

Monday,...
Agenda
o The three questions on Founders’ Agreement
o The constituents of a Founders’ Agreement
•
•
•
•
•
•
•

Standard Te...
QUICK POLL

How many Entrepreneurs in the room believe
that a Founders’ Agreement executed orally
is legally enforceable?
The Three Questions on Founders’ Agreements
What is a Founders’ Agreement: A contract between
founders/promoters of a busi...
The Three Questions on Founders’ Agreements
oTo provide for contribution, allocation and distribution
of resources
oTo pre...
QUICK POLL

Can an investor force a founder to sell his/her
shareholding in the start up?
The constituents of a Founders’ Agreements
oStandard Terms of a Founders’ Agreement
•
•
•
•
•
•
•
•
•
•
•
•

Equity Invest...
Board Constitution
oOptimum Board Structure - a balancing act
•What should be the size of the Board/Odd number
structures
...
QUICK POLL

Does the Indian legal system allow individuals to take an
equity stake in a start up by making contributions i...
Contribution
oContribution – Nature and Nurture
•Employee or shareholder or both
•What will be the form of contribution by...
QUICK POLL

Can an angel investor with 10% shareholding, prevent a
start up from taking money from a VC in the next round?
Vesting and Control
oOwnership / Control - Shareholding Control
•Will all shares be allotted upfront or will there be
mile...
Vesting and Control
Shareholding

Level of control over Indian Company

<10%

A derivative action in the name of the share...
Transfer Restrictions
o Restrictions on transferability
• Should there be a lock-in?
• What happens if a founder wants
to ...
QUICK POLL

How many Founders here think that the
ownership of the IP developed by the
founder/employee of a start-up, wil...
Intellectual Property Rights & Promoter
Covenants
oIntellectual Property Rights
• Protection
• Ownership
oPromoter Covenan...
Jurisdiction and Termination
oJurisdiction and Termination
• Jurisdiction of the Founders’ Agreement
• Modes of Dispute Re...
Watch-Out Issues
oEnsure that contract is valid and properly executed
oExpressly provide for consideration
oStamp the cont...
THANK YOU

96, Free Press House
215, Nariman Point
Mumbai – 400 021
Telephone: +91 22 6749 2595
Facsimile: +91 22 6749 259...
Founders' agreement - A critical start for a start-up (Naina Krishnamurthy K Law 251013)
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Founders' agreement - A critical start for a start-up (Naina Krishnamurthy K Law 251013)

  1. 1. Founders’ Agreements A Critical Start for a Start-Up By Naina Krishna Murthy Managing Partner Krishnamurthy & Co. Monday, 28th October, 2013
  2. 2. Agenda o The three questions on Founders’ Agreement o The constituents of a Founders’ Agreement • • • • • • • Standard Terms Board Constitution Contributions Vesting and Control Transfer Restrictions Intellectual Property Rights and Promoter Covenants Termination and Jurisdiction o Watch Out Issues o Questions?
  3. 3. QUICK POLL How many Entrepreneurs in the room believe that a Founders’ Agreement executed orally is legally enforceable?
  4. 4. The Three Questions on Founders’ Agreements What is a Founders’ Agreement: A contract between founders/promoters of a business ooutlining mutual understanding and setting out expectations of each party ostreamlining investment and distribution of money and highlighting roles, responsibilities and obligations of each party Why do we need a Founders’ Agreements: o to record understanding in order to avoid any ambiguity in future o to set expectations, align goals and assign responsibilities
  5. 5. The Three Questions on Founders’ Agreements oTo provide for contribution, allocation and distribution of resources oTo pre-empt possible hurdles and identify ways to tackle them When to enter into a Founders’ Agreement: oIdeation stage oIncorporation stage oCapitalization stage It is Advisable to enter into a written agreement to avoid ambiguity in enforcing oral contracts. Further, the agreement should ideally be entered into at the incorporation stage since there would be some amount of investment of time and money by then.
  6. 6. QUICK POLL Can an investor force a founder to sell his/her shareholding in the start up?
  7. 7. The constituents of a Founders’ Agreements oStandard Terms of a Founders’ Agreement • • • • • • • • • • • • Equity Investment and Capital Structure Board Management and Deadlock Shareholders’ Meeting Fresh Issue and Transfer Restrictions Vesting Business, Business Plan, Accounts and Policies Confidentiality, Non-compete and Non-solicit Representation and Warranties Indemnity Termination and Consequences Governing Law and Dispute Resolution Boiler Plates
  8. 8. Board Constitution oOptimum Board Structure - a balancing act •What should be the size of the Board/Odd number structures •Will all the founders be on the Board •Who will be the Chairman of the Board and will the Chairman have veto rights •Unanimous Voting Rights • Advisable to have a legal entity in place before money and business ideas are brought to the table • Company is a commonly preferred structure
  9. 9. QUICK POLL Does the Indian legal system allow individuals to take an equity stake in a start up by making contributions in kind?
  10. 10. Contribution oContribution – Nature and Nurture •Employee or shareholder or both •What will be the form of contribution by a founder – cash or kind •How would you value non cash contribution •How will the shareholding be distributed amongst founders •How much are the founders willing to dilute in the future • • • Minimum shareholding/capitalization requirements under the law Valuation of assets/intangibles important from tax perspective Incase of foreign founders, contribution has to be in cash or against lump-sum payment/royalty
  11. 11. QUICK POLL Can an angel investor with 10% shareholding, prevent a start up from taking money from a VC in the next round?
  12. 12. Vesting and Control oOwnership / Control - Shareholding Control •Will all shares be allotted upfront or will there be milestones based on which shares are vested •What are the different possible dilution events •What is the extent of dilution •Should a shareholder be given veto rights •Pre-emptive rights •Enforceability • • Control rights available under the law at different levels of shareholding (Discussed in the next slide) Minority shareholders are given protection under law
  13. 13. Vesting and Control Shareholding Level of control over Indian Company <10% A derivative action in the name of the shareholder to the Court of Law on behalf of the Company. 10% - 25% Minority protection rights for relief against oppression and mismanagement. 25.01% 49.99% Can block matters requiring a special resolution (75% voting in favour), which include alteration of Charter Documents, amalgamation and mergers, preferential issues of shares, other rights stipulated in the Articles. 50% Can block all resolutions requiring approval of shareholders by ordinary resolution. 50.01% 74.99% Has majority rights and control over matters requiring ordinary resolution (simple majority), which include the appointment of directors, declaration of dividends, appointment of auditors, issue of shares on a rights basis, etc. 75% - 89.99% Has the ability to pass both ordinary and special resolutions. 90.01% Has effectively full control since minority protection is generally available to shareholders holding 10% or more shareholding.
  14. 14. Transfer Restrictions o Restrictions on transferability • Should there be a lock-in? • What happens if a founder wants to sell his stake? • Right of First Refusal/Offer • Tag Along Rights • Drag Along Rights • Transfer upon death or termination of Agreement In case of private limited companies, these are contractual rights
  15. 15. QUICK POLL How many Founders here think that the ownership of the IP developed by the founder/employee of a start-up, will vest in the start up?
  16. 16. Intellectual Property Rights & Promoter Covenants oIntellectual Property Rights • Protection • Ownership oPromoter Covenants • Exceptions • Non Compete Obligations • Compensation (whether cash or past considerations) • Restriction as an employee vs. founder • Non-solicitation
  17. 17. Jurisdiction and Termination oJurisdiction and Termination • Jurisdiction of the Founders’ Agreement • Modes of Dispute Resolution • Circumstances for Termination • Consequences of Termination • Asset distribution post Termination • Restrictive Covenants • Winding up proceedings could be time consuming • Enforceability of non-compete restrictions amongst shareholders • Distribution of capital
  18. 18. Watch-Out Issues oEnsure that contract is valid and properly executed oExpressly provide for consideration oStamp the contract with applicable stamp duty oProvide for severability of clauses not recognized under Indian laws oIncorporate provisions into Articles of Association In case any party executing is a corporate entity, ensure that the entity has appropriate authority to enter into contract.
  19. 19. THANK YOU 96, Free Press House 215, Nariman Point Mumbai – 400 021 Telephone: +91 22 6749 2595 Facsimile: +91 22 6749 2593 4th Floor Prestige Takt No 23, Kasturba Road Cross Bangalore - 560 001 Telephone: +91 80 4175 7500 Facsimile: +91 80 4175 8000 A 457, Defence Colony New Delhi – 110 024 Telephone: +91 11 4617 0292 Facsimile: +91 11 4617 0293 No. 5B-1, 5th Floor Premises New No. 71 (Old No. 35) Venkatesh Bhavan Armenian Street George Town, Chennai – 600 001 Telephone: + 91 44 4214 2952

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