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Individuals entering the world of entrepreneurship seek flexible methods of conducting business, especially when it comes to schemes that allow for the improvement of an evolving management process and collaboration among partners. A helpful solution in that regard is a start-up – below we explain how to establish one in Poland and most importantly: what is the founders’ agreement?
How Does a Start-up Work?
A start-up is an organizational model frequently chosen by newly-established, developing companies still seeking to achieve a stable market position. They aim to find the best way to conduct business through continuous testing and optimization. In practice, the operation of a start-up is based on the constant Deming cycle.
This means that the life cycle of a company consists of four stages:
- Plan – during this stage, preliminary project assumptions are developed and, without excessive focus on details, potential buyer profiles and marketing strategies are created ;
- Do – this phase aims to implement the planned solution as quickly as possible to test whether it yields the desired results at a low cost;
- Check – after the implementation phase, data on reactions to the product and interest in it are collected;
- Act – the stage of planning improvements and optimizing solutions.
In a start-up, the goal is to minimize the duration of each of these phases, enabling successive improvements to be introduced at a relatively low cost. What distinguishes many start-ups is their small size. They are often financed directly from the partners’ funds or:
- through crowdfunding,
- by investment funds,
- by business angels.
This business model can work in nearly any industry, although it typically applies to sectors that promote innovation, internet applications, and computer systems.
Typical characteristics of a start-up include:
- low operating costs,
- business linked to high-risk, production of innovative or novel solutions,
- short operating time (around 5 years), followed by stabilization of the financial model,
- focus on rapid growth,
- search for an optimal operating and financing model that allows easy scalability and dynamic adaptation to changing market conditions.
Start-ups are not always highly formalized. They can operate under any legal framework – from sole prorietorship’s cooperations to joint-stock companies, etc. What’s important here, before individuals decide to register a new entity, they can secure their business model by entering into a founders’ agreement.
What Is a Founders’ Agreement and Why Is It Established?
A founders’ agreement is a foundational document. It is not the same as articles of association. It doesn’t create or register a separate legal entity and is not obligatory for the start-up’s existence.
A founders’ agreement includes fundamental issues related to the start-up’s operations, the rights and obligations of partners, and methods of seeking financing. Often, information about Key Performance Indicators (KPIs), which are economic indicators used to assess investment profitability, is also added. These provisions don’t have to be included in the articles of association.
The purpose of a founders’ agreement is to establish a framework for collaboration in two stages:
- before formal business operations commence (pre-formation founders’ agreement),
- during the course of operations (shareholders agreement).
It’s also a way to minimize the risk of legal disputes by clearly delineating competencies, duties, and responsibilities.
There is no hindrance for partners/shareholders already operating a business together to establish a new start-up and sign another pre-formation founders’ agreement to regulate it.
What Should Be Included in a Founders’ Agreement?
The content of a founders’ agreement is not regulated by any specific laws, so it’s generally considered an unnamed agreement, often made in written form. However, when formulating its provisions, individuals working together must adhere to the following:
- widely applicable legal regulations,
- social norms,
- the essence of the given legal relationship.
The agreement’s content will depend on how formalized the relationships between the partners should be. For yet to be launched start-ups, simpler models of founders’ agreements often work. However, much depends on the partners’ efforts, commitment to the business, and the specifics of the given activity.
In industries where know-how holds immense value, such as the IT sector or online marketing, reservations are usually plentiful. What arrangements are worth considering in a founders’ agreement?
Purpose and Nature of the Venture
In the agreement, it’s valuable to define the scope of the start-up’s activities precisely. Not only does this facilitate the formulation of the final articles of association, but it also allows for better business planning and expenditure optimization by focusing resources where they are needed.
The venture’s purpose should be articulated so that, after a certain period, those collaborating can unequivocally determine whether it has been achieved within the established timeframe. This is why specific KPIs are added to the founders’ agreement, such as:
- number of inquiries for proposals,
- number of signed agreements with new clients,
- net revenues,
- number of customer complaints,
- the average value of purchased products.
Numerous efficiency indicators exist, but they should align with the nature of the business conducted. Different values will be significant for an online store compared to a company involved in HR processes.
By stipulating contributions, partners declare the assets they can bring to the company’s future resources. This facilitates business development planning, as business plans can consider specific values. It’s important to remember that contributions can be more than just monetary. On the contrary, in low-budget start-ups, they are often:
- machinery and equipment,
- personal labor.
Profit Sharing and Loss Participation
These issues often become contentious in many businesses. The model solution assumes equal profit and loss sharing, but in practice, this needs to be adjusted according to the contributions made by partners, their involvement, and internal agreements. Often, individuals deriving more significant profits will also have a greater stake in losses, or vice versa – those possessing essential know-how might be entirely excluded from loss participation. There’s also no restriction against having no correlation between the amount of contributions and the amount of profits.
Shares in profits and losses are expressed as percentages. This allows for easy determination of the monetary range of wealth redistribution.
Management and Representation of a Start-up
To ensure smooth collaboration, it’s necessary to regulate the decision-making process. Relations between participants lay at the core of management of the entity. This concept includes deciding on project management, partner relations, and the internal division of responsibilities. On the other hand, representation designates who will act on behalf of the entity externally, identifying individuals responsible for signing agreements and representing the entity in negotiations with clients, among other tasks.
Appropriately regulating internal and external management processes prevents conflicts and ensures seamless operation of the start-up.
Founders’ Rights and Obligations
This aspect primarily concerns mutual communication not only between partners but also between partner and client. Rights and obligations are not just declarations; they provide a way to stipulate specific types of actions that can be demanded from individual partners. These may pertain to:
- the obligation to undertake particular actions for the benefit of the start-up,
- independent decision-making on business matters,
- attendance at meetings,
- maintenance of a specific document circulation method.
Issues Related to Copyrights
During start-up activities, many works are created that fall under copyright protection. As long as these are created by employees under an employment contract, this is a minor issue. However, when individuals are employed under civil law contracts, questions arise regarding the following:
- the transfer of copyright’s economic rights to the created works,
- separate remuneration for the transfer of copyright,
- the amount of copyright costs (20% or 50%),
- documentation of the time of work creation (for determining copyright costs).
These issues are also worth addressing in the founders’ agreement, along with the issue of granting licenses and specifying exploitation rights.
Equity Vesting in a Start-up
To stabilize collaboration and enhance the commitment of individuals co-creating the start-up, it’s advisable to consider incorporating a vesting clause into the founders’ agreement. This involves increasing equity or granting specific privileges conditional upon working for the start-up for a defined period (e.g., several years). This way, the entity can safeguard against the loss of critical managerial staff.
A founder’s agreement can be very simple or quite extensive. To avoid giving the impression that the partners have essentially entered into a civil partnership, it’s advisable to include a reservation in the founders’ agreement, excluding provisions regulating this legal construct.
Common Mistakes to Avoid When Drafting a founders’ Agreement
When drafting a founders’ agreement, various errors should be avoided. Some will be immediately apparent, while others may have negative consequences only after an extended period. What should be kept in mind?
- Match the corporate form to the purpose and method of the start-up’s business activities.
The legal form entails more than just a name. It defines, among other things, the scope of partners’ liability, operational rules, and internal structure. In cases where a limited liability company is suitable, a sole proprietorship might be less effective.
- Never solely rely on handshake deals.
Verbal agreements, or handshake deals, rely on the parties’ good faith. However, it’s uncertain whether, in the absence of willingness to cooperate, it will be possible to enforce specific rights or obligations. Unfortunately, enforcing an oral agreement can be very challenging.
- Intellectual property protection is not a waste of money.
Investing in trademarks, geographical indications, or industrial designs is a long-term investment. You can effectively enforce your IP rights through protection guaranteed by intellectual property law.
A well-constructed founder’s agreement should encourage partners to continue collaborating. Contrary to appearances, it’s a solution not only for large companies planning to go public. Small, two-person start-ups entering the market can also benefit from it. If unsure how to construct an effective founders’ agreement, seeking assistance from a legal firm is recommended.