Many startup founders spend months refining their pitch decks and days negotiating investor term sheets, while spending almost no time on the document that governs the relationship between themselves, the founders’ agreement. This is a mistake. Co-founder disputes are among the most common causes of startup failure. A well-drafted founders’ agreement anticipates and provides for the scenarios that destroy co-founder relationships, equity division, exit of a co-founder, IP ownership, and decision-making, before those scenarios arise.
A founders’ agreement is a contract between the co-founders of a startup that governs their rights and obligations in relation to each other and the company. It should be signed before or contemporaneously with the company’s incorporation, ideally, it is signed at the same time as the Shareholders’ Agreement (if any) and the employment or consultant agreements of the founders.
A founders’ agreement is not a shareholders’ agreement with investors, it is between the founders themselves. In many startups, this document is never drafted because the founders trust each other and believe they can resolve issues informally. This trust is not a substitute for documentation.
Equity Split: Getting It Right on Paper
The equity split between co-founders is the most fundamental decision in a startup’s life. Many startups divide equity equally among co-founders regardless of differences in contribution, skill, time commitment, or capital invested. Equal splits are easy but frequently produce significant resentment over time.
The founders’ agreement should record: (a) the agreed equity split; (b) the rationale (each founder’s contribution: idea, capital, development, business relationships, full-time versus part-time commitment); and (c) whether the split is subject to adjustment during a vesting period.
Documenting the rationale serves two purposes: it forces the founders to have an explicit conversation about their relative contributions before disputes arise, and it creates a record that may be relevant if the split is later challenged.
The agreed split should be reflected in the company’s shareholding from the date of incorporation, not “we’ll sort it out later.” MCA records must be consistent with the founders’ agreement.
IP Assignment: No Startup Without Clean IP
A founders’ agreement must include an IP assignment clause requiring each founder to assign to the company all intellectual property created by or for the startup, including:
- Software code and architecture (including code written before incorporation)
- Product ideas, prototypes, designs
- Business methods and processes
- Content, data, and databases
- Domain names, social media handles, and brand assets
- Trade secrets and know-how
Under Section 17 of the Copyright Act, 1957, copyright vests in the author, meaning that code written by a founder belongs to that founder, not the company, unless it is expressly assigned in writing. The founders’ agreement is the natural place to include this assignment, signed at or before incorporation.
The IP assignment should be drafted in the present tense (“hereby assigns”) and should cover both existing IP and all IP created in the future during the term of the founders’ engagement with the company.
Vesting Schedule: The Most Important Protection
Without a vesting schedule, a co-founder who leaves after six months can walk away with their full equity stake. The remaining founders continue to build the company while carrying the dead equity of a departed colleague. Investors will not fund a company where a departed founder holds 25-33% equity without vesting.
The mechanics of reverse vesting:
Founders in a startup typically receive their shares at incorporation. Reverse vesting works as follows: the founders’ shares are all issued upfront, but the company has a right to buy back any “unvested” shares at face value (or a nominal amount) if the founder leaves before the vesting schedule completes.
Example: Founder holds 25% (250,000 shares). 4-year vest, 1-year cliff. If the founder leaves after 6 months, all 250,000 shares remain subject to the company’s buyback right, none have vested. If the founder leaves after 18 months, 25% of shares (62,500) have vested (1/4 vest at 1-year cliff + 6/36 months × 75% = approximately 37.5%) and the company can buy back the remaining unvested shares.
Cliff vesting: The “cliff” is a minimum threshold period before any vesting occurs. The standard 1-year cliff means: if a founder leaves before 12 months, no shares vest and the company can buy back all of them. This protects against a co-founder who is not committed from the start.
Acceleration: A founders’ agreement typically provides for “double trigger” acceleration, where both (a) a change of control of the company (acquisition) and (b) the founder is terminated without cause following the acquisition, the remaining unvested shares vest immediately. This is fair to founders and does not unduly disadvantage acquirers who need key founders to remain post-acquisition.
Roles and Decision-Making
The founders’ agreement should specify:
- Designated role of each founder (CEO, CTO, CPO, COO, etc.)
- Day-to-day authority, what each founder can do unilaterally within their functional area
- Reserved matters requiring all-founders consent, fundamental business decisions (change of business direction, bringing in a new co-founder, issuing new equity, entering major contracts) should require unanimous or supermajority founders’ consent
- Mechanisms for resolving deadlocks, most founders’ agreements provide for an escalation procedure (discuss in good faith for X days; if unresolved, refer to a named mediator or senior advisor)
Non-Compete and Non-Solicitation: What Is Actually Enforceable
Section 27 of the Indian Contract Act, 1872 provides that every agreement in restraint of trade is void. This has been consistently applied by Indian courts to render post-employment non-compete clauses unenforceable.
During the engagement: A covenant restricting a founder from competing with the company while they are a founder and working full-time is enforceable, it is not a restraint on trade because the party is currently engaged and compensated.
Post-exit: A blanket non-compete preventing a departed founder from ever working in the same industry is unenforceable under Section 27. However, narrow non-solicitation clauses, preventing the former founder from directly soliciting specific named clients or employees of the company for a defined period (12-24 months), are more likely to be enforced.
The founders’ agreement should not purport to enforce an unenforceable non-compete. Instead, it should focus on: (a) protecting confidential information; (b) preventing solicitation of specific clients and employees; and (c) maintaining the IP assignment obligations post-exit.
What Happens When a Founder Exits
The founders’ agreement should include a clear mechanism for what happens when a co-founder leaves:
- Buyout provision: the remaining founders (or the company) have a right to purchase the departing founder’s unvested shares at face value (as part of the reverse vesting mechanism) and the vested shares at a fair value determined by an agreed formula or an independent valuer
- Right of First Refusal (ROFR): if a departing founder wishes to sell their vested shares, the remaining founders and the company have ROFR at the same price and on the same terms
- Drag-along: if a super-majority (e.g., 75%) of founders wish to sell the company, they can require the remaining founders to sell their shares on the same terms
- Post-exit obligations: the departed founder remains bound by confidentiality and IP assignment obligations regardless of when they exit
Dispute Resolution Between Founders
Litigation between co-founders in Indian courts is company-destroying, it creates public visibility of internal conflict, freezes the company’s ability to make decisions, and is expensive and slow.
The founders’ agreement should require: (a) a 30-day good faith negotiation period; (b) mediation (with a named mediator or under ICADR or SAMA rules); and (c) binding arbitration as a last resort.
Institutional arbitration (Delhi International Arbitration Centre or Mumbai Centre for International Arbitration) is preferred for its procedural efficiency over ad hoc arbitration.
Key Takeaways
- A founders’ agreement must include an IP assignment clause, under Section 17 of the Copyright Act, 1957, intellectual property vests in its creator (the individual founder), not in the company, and a written assignment is the only way to transfer this ownership.
- Reverse vesting (4-year schedule, 1-year cliff) is the most important protection against a co-founder leaving early with full equity, without vesting, a departed founder retains dilutive equity that investors will not accept and that damages the company’s ability to raise funding.
- Post-exit non-competes are unenforceable under Section 27 of the Indian Contract Act, 1872, the founders’ agreement should instead focus on enforceable protections: confidentiality obligations, narrow non-solicitation of named clients and employees, and continuation of IP assignment obligations.
This article is for informational purposes only and does not constitute legal advice. Readers should seek appropriate professional counsel for their specific circumstances.
META TITLE: Founders Agreement India: Why It Matters and What to Include