How to Create the Perfect Cofounder Agreement with Your Business Partner

You’ve just conceived a brilliant billion dollar startup idea; you’ve defined the perfect value proposition for you company; and you just met the perfect co-founder (or co-founders) to help you get your idea off the ground.

You’re ready to build a startup, right?

Not quite. If you plan on starting a business with others, it’s imperative that you all set aside some time to discuss and work out a co-founder agreement. You may get along wonderfully at the outset, but as your company grows and expands, you may discover that you have differences regarding the future of your startup or its mission. And when these differences arise while the company is operating, this will only compound problems.

However, we’ve gathered the best opinions from top startup experts to help ensure that you and your partner align your goals and establish a strong co-founder relationship for your company.

How to Ensure Alignment of Vision

As you and your co-founder (or co-founders) embark on your entrepreneurial journey together, it’s imperative that you all share the same vision for the purpose and future of your company. It’s easy to get caught up in the thrill of launching a potentially successful startup together, but you all must take the time to establish the existential foundations of the company, and as early as possible, to help prevent the possibility of a drastic falling out later on.

In the guest blog post “8 Issues You Need to Discuss with Your Co-Founder” on CoFoundersLab, David Ehrenberg (CEO of Early Growth Financial Services) outlines several concerns that cofounders must address before launching a company together. Below are some of the most important ones, organized by topic:

What Are Your Goals?

• Why are you creating this startup?
• What need will it fill?
• What will your initial product/service offering be?
• And what is your strategy for growing the company?

What Are Your Company Values and Philosophy?

• Your company’s success depends on vision alignment (alignment between you and your investors, your employees, and your customers, etc.). Do you share the same priorities? Do you agree on what’s most important to you both personally and for the future of your company?

How Do You Measure Success?

• What do you and your co-founder(s) hope to get out of this business?
• How will you know if you’ve achieved your goals?
• If you don’t agree on the same goals, how will you know when you’ve achieved them?

Discussing these issues with your co-founder could get uncomfortable, create rifts, or even uncover deal-breakers. If you are able to successfully have these difficult conversations, this is a testament to your partnership and to the strength of your relationship -- and will serve as a solid foundation from which to grow your business." - David Ehrenberg

Working Styles and Culture

Once you and your cofounder have laid down the aspirational and philosophical groundwork for your startup, this is also the ideal time to determine what kind of working environment best complements the vision of your startup.

In the FounderDating blog post, “34 Questions to Ask a Potential Co-Founder”, Jessica Alter (Founder and CEO of FounderDating) lists the questions you should ask your cofounder to define your ideal working conditions for your company.

1. What 3 words best describe the startup culture you want to create (e.g. open, hard-working, eccentric, etc.)? Pro-tip: If you’re really serious and far along go visit few office spaces together to get a sense of what each of you likes work environments wise and why.
2. What values do we want to instill in our employees?
3. If you could pick 2 things to change about our company, and two things to bring with you from your previous experience, what would they be and why?
4. How much equity are we allocating for future employees?
5. What should we look for in our first 5 hires?
6. Describe your ideal working style.

And as exhaustive as this list might be, in order to really understand how you work with someone you have to. actually work with them. Once you’ve agreed you’re aligned on a lot of the categories above, start a side-project, go to a hackathon (or 2). It’s really the only way to tell." - Jessica Alter

How to Determine Roles

Once you and your founding team have settled on the overall scope and mission of your company, take the time to define your respective roles and which team member will oversee what. While the functions of formal roles tend to change (especially for recently established startups), the Steve Robbins-penned Entrepreneur article, “Build Your Management Team”, outlines the general functions of each formal role. The definitions below should help you get started picking your respective roles:

Chief Executive Officer (CEO)

• Basically, the CEO is the boss of everyone at the company and is responsible for everything. They determine the company's strategy, hire and build the senior team, and make the final call on how resources are used.

Chief Operating Officer (COO)

• The COO handles a company's complex operational details and insures the business can deliver each day, as well as figures out what needs to be measured to determine if things are going well.

Chief Financial Officer (CFO)

• Your CFO handles the money by creating budgets and financing strategies. CFOs make decisions like if it's better for your business to lease or buy, and build the control systems that monitor your company's financial health.

President

• The role of a president is often somewhat vague, and many startups feel they are unnecessary. Some say a president oversees staff functions, like human resources, finance and strategy, while others state that the president is essentially the same as a COO, but for smaller companies.Think long and hard about whether your company needs someone to fill this title, or if your company is fully covered with a CEO and COO.

Chief Marketing Officer (CMO)

• The CMO manages the marketing strategy (and often the sales strategy) and oversees its implementation. The CMO should know your industry inside out, and helps you position your product, make it stand out from existing products, and make ensures that customers learn to crave your product.

Chief Technology Officer (CTO)

• A CTO keeps abreast with technology trends, integrates those trends into the company's strategy, and makes sure the company keeps current when necessary. If technology impacts your business or industry strategically, you’ll need a CTO on hand.

Building your team demands matching jobs to people's strengths. That means giving people responsibilities according to skill level, not based on how close a friend they are, or how closely related they are to you, or whether you just like their sunny personality. That includes you as well - don't give yourself an impressive title and job unless you're right for the job." - Steve Robbins

Legal Decisions & Definitions

Most founders who set out to launch tech companies have little to no legal experience, which can lead to problems down the road, especially when investors and lawyers get involved. While entrepreneurs aren’t required become legal experts to build companies, taking the time to become with basic legal practices can only benefit one’s company. To get you started below are several elementary legal questions you and your cofounder should address, taken from the Forbes article, “10 Big Legal Mistakes Made By Startups”, by Richard Harroch.

General Questions

• Is the percentage ownership subject to vesting based on continued participation in the business?
• If one founder leaves, does the company or the other founder have the right to buy back that founder’s shares? At what price?
• What salaries (if any), are the founders entitled to? How can that be changed?
• How are key decisions and day-to-day decisions of the business to be made?

Basic Legal Definitions

Harroch's article also explores numerous basic legal terms associated with launching a startup, all of which you and your business partner should familiarize yourselves with.

• Confidentiality Agreements - These are also referred to as Non-Disclosure Agreements or NDAs. The purpose of the agreement is to allow the holder of confidential information to share it with a third party.
• Copyright - A copyright gives the owner the exclusive right to make copies of the work and to prepare derivative works (such as sequels or revisions) based on the work.
• General Partnership - If there is more than one founder, a general partnership is often chosen as the legal form of business entity.
• Patent - A patent gives its inventor the right to prevent others from making, using, or selling the patented subjected matter described in words in the patent’s claims.
• Service marks - Service marks resemble trademarks and are used to identify services.
• Tax Incentive - Depending on the nature of the business, various tax incentives may be available, such as renewable energy tax credits and investment tax credits.
• Trademark - A trademark right protects the symbolic value of a word, name, symbol, or device that the trademark owner used to identify or distinguish its good from those of others.
• Trade Secret - A trade secret right allows the owner of the right to take action against anyone who breaches an agreement or confidential relationship or who steals or uses other improper means to obtain secret information.

You absolutely have to agree with your co-founders early on what the deal is among you. Not doing so can cause enormous problems later (see, for example, the Zuckerberg/Winklevoss Facebook litigation). In a way, think of the founder agreement as a form of 'pre-nuptial agreement'." - Richard Harroch

Now let’s take a look at a couple more advanced startup legal topics that you should address when launching a company with others. In “Common Legal Mistakes Made by Startups (And How You Can Avoid Them)”, Matt Glick of Legal Hero expounds on the requirements for establishing a solid legal foundation for a startup.

Include a Vesting Schedule When Issuing Shares to Co-founders

• When you create a vesting schedule, this means that the co-founder will earn their shares over time and protects you and the company if that a co-founder leaves the company or doesn't pull their weight. The standard vesting period is four years, with monthly vesting of shares. Unvested shares should be subject to repurchase by the company if the co-founder leaves the company.

Protect Your Valuable Intellectual Property

• If intellectual property is a vital element of your business, it's important to protect that IP during the formative stages of a company. You can address this issue by relying on patents, trademarks, copyrights, and trade secrets to protect your valuable IP. Another step you can take is requiring all co-founders and any third-party developers to assign to the company their rights in IP they created and that is utilized by the company. Doing this will help prevent trouble if a co-founder leaves the company and takes a crucial patent with them.

Use the free guide thousands of entrepreneurs trust: Founder / Advisor Standard Template (FAST)

With so many demands on your time, one of the areas that often slips through the cracks is establishing a solid legal foundation for your company. Although there is no set amount of time, energy, and money a company should spend on legal early on, if you're operating in a heavily regulated area - such as crowdfunding, payments, or health care - you'll want to focus more on legal than if you're creating the next Candy Crush." - Matt Glick

How to Split Equity

And now for the part you’ve all been waiting for: how to split equity among cofounders. While it may easy to merely assume that splitting equity equally between cofounders is the way to go, once you start delving into into who brings what to the company, you’ll discover that “equal share” doesn’t add up to “fair share”. Just ask Dan Shapiro, CEO of Glowforge and Founder Institute Mentor. In his GeekWire article, “The only wrong answer is 50/50: Calculating the co-founder equity split”, Dan posits that equity share should be calculated from the founder’s worth. Here’s what Dan has to say on determining equity share from what each founder contributes:

Ideas are Valuable

• If you brought the original concept to the table, increase your share holdings by about 5 percent. While execution is more important in the long run, whoever conceived the original idea deserves a little extra credit.

That First Step is a Doozy

• Bringing something of value to the company during its formative stages – like a filed patent (not a provisional), a compelling demo, an early version of the product, or something else that means much of the work towards financing or revenue is already done – you should receive a considerable part of the equity.

Full Time Commitment is Expensive

• Bottom line, if you’re working more, then you’re risking a lot more if the project fails, which means that you are entitled to more if the project succeeds. Also, keep in mind that part-time cofounders are a big minus to someone considering an investment, so choose your partners wisely.

The CEO Gets More. Always.

• Splitting equity equally means that no one controls the company more than anyone else. But if that’s the case, than having a CEO is useless, as well as having any form of upper management. So, whoever is the designated CEO should get another slightly more equity. If you think that’s unfair, remember that market rate for a great CEO is higher than market rate for a great CTO, which means that’s how it is everywhere.

Reputation Counts

• If you’re a beginning entrepreneur and your partner is an experienced founder with an established reputation, they deserve more equity. If that founder has an expansive network that benefits the company, they deserve more equity. If that founder can help secure more funding for your company, they deserve more equity.

The question of equity brings out the most fundamental differences, perceptions, and values in an aspiring startup. In fact the equity question, more than any other, may strangle a young company before it can even get started. And that’s a damn good thing." - Dan Shapiro

If you want more information on such a sensitive topic, check out our previous blog posts on the matter:

• How to Split Equity with Cofounders
• A Guide to Startup Employee Equity

And as a bonus, be sure to download the Co-Founder Equity Split Spreadsheet has 5 different calculators in it, and a final box that averages everything out among all five.

Final Thoughts

Yes, talking about such topics as company roles and vision and equity and the like can be uncomfortable among founders. However, these discussions are vital to a successful partnership, as well as a successful startup, and must be held before any of you invest too much time, energy, and money into a potential company. Keep in mind that whoever you decide to launch a company with, you all will have to make countless difficult decisions once your company is actually up and running. If you take nothing else from this blog post, at least follow the bit of advice below:

Choose co-founders the way you would choose a spouse. The reality is that you will, at least in the early days, spend far more time with your co-founders than your partner.” - Danielle Newnham, author of Mad Men of Mobile