Structuring Founder Relationships
How are founder relationships structured for a company? Here are some of the key legal considerations we will discuss with you:
- Single Founder: Are you the only founder of your company? If so, and you form a corporation, you will typically be the sole shareholder, sole director and sole officer of the company. If you form an LLC, you will typically be the sole member and sole manager of the company. Do you understand each of your roles and the separate responsibilities of each capacity? Do your company documents reflect each of these roles?
- Multiple Founders: Are there multiple founders of your company? If so, it is critical to determine and document the rights, roles and responsibilities of each founder at the outset. In addition to the legal rules applicable based on the type of entity you’ve formed, you may want to consider adopting a Shareholder Agreement or Buy-Sell Agreement to further define everyone’s expectations, especially regarding future ownership and founder departures.
- Shareholders: Issuing stock to founders and others determines how much of the company is owned by each founder. Undocumented promises of stock determine who may be suing the company in the future, especially if the company is successful. Stock ownership confers both economic interest and the right to elect the board of directors to govern the company. Shareholders may or may not also be directors and may or may not also be officers.
Percentage ownership is always based on the relative holdings of each shareholder. If three founders each receive 1,000 shares, then each owns 33.33% of the company until there is a change in issued shares. (Don’t confuse issued shares with authorized shares. The number of authorized shares is stated in the articles/certificate of incorporation and is the maximum number of shares that can be issued until the articles/certificate is amended. Only shares that are actually issued, however, are used in the calculation of ownership. If a corporation has 10,000,000 authorized shares and issues only 1 share, the holder of that share owns 100% of the corporation.) Have you determined how much each founder will own and how much each founder will pay for shares? Are there intangible assets (such as a business plan or software code) or tangible assets (such as desktop or laptop computer or office equipment) that will be contributed to the company as part of the payment for shares? Note that the issuance of shares in exchange for services (versus cash or other assets) is generally taxable!
- Board of Directors: A corporation is required to have a board of directors responsible for the management of the company. An LLC may or may not have a board of managers depending on the operating agreement. The board of directors of a corporation is elected by the shareholders of the corporation. The board of managers of an LLC is typically elected by the members of the LLC, if provided in the LLC operating agreement. The board of directors, acting as a group, is generally the highest management authority of a corporation. The board of directors sets overall direction of the corporation and elects the officers of the corporation to manage day-to-day business. The board must also approve each issuance of stock or options. Will each founder be a member of the board of directors? Note that a Delaware corporation can have a board of directors composed of one or more directors, regardless of the number of stockholders. A California corporation must have at least three directors if there are three or more shareholders, at least two directors if there are two shareholders, and at least one director if there is only one shareholder. Directors may or may not also be officers and may or may not also be shareholders.
- Officers: Officers are responsible for the day-to-day operation of the company, subject to the supervision of the board of directors. A corporation is typically required to have a chief executive officer/president, a chief financial officer/treasurer and a secretary. Additional titles may be conferred by the board of directors, such chief operating officer, chief technical officer, vice president, and so forth. The board may assign specific duties to specific officers. An individual may hold more than one office. Have you determined who will hold each required office and any additional offices? Do the corporate bylaws reflect the officer titles you plan to use? Officers may or may not also be directors and may or may not also be shareholders.
- Shareholder and Buy-Sell Agreements: Founders should consider adopting a further agreement that covers issues not addressed in the articles/certificate of incorporation and bylaws. Are the founders expected to fill certain roles not covered by their officer titles? Do the founders agree always to vote for a particular slate of directors? What happens if a founder stops working for the company? Does the founder get to keep his or her shares or does the company have a right to purchase the shares? If the company can purchase the shares, how is the price determined? Does the founder remain on the board of directors? A shareholder agreement or buy-sell agreement provides a mechanism to resolve these issues as determined in advance by the founders.
- Invention Assignment Agreements: Is any founder bringing intellectual property to the company, such as a business plan or software code written before the company incorporated or organized as an LLC? It is critical that the transfer of preexisting and future intellectual property from founders and other contributors be documented clearly. Preexisting intellectual property is frequently assigned to the company as part of the purchase price of shares issued to founders.