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Enforceability risks

Co-founders agreements are intended to be extremely simple and to be used at extremely preliminary stages of a business, at a point where the co-founders do not contemplate detailed legal compliance and documentation.

However, if a co-founders agreement is understood as a partnership by a court, its enforceability may be difficult (except for extremely limited purposes). Partnership agreements are only enforceable if they are registered with the Registrar of Firms in the state where the business is being carried out in order to be enforceable. There is a chance that the provisions governing economic interest of the co-founders and capital contribution lead a court to infer that it is a partnership.

How should you ensure that your co-founders agreement is enforceable?

A co-founders agreement is typically ideal for the stage before a ‘business’ has come into existence – that is, when the product or service is being created. At this stage there are barely any revenues or profits in existence, therefore the agreement primarily focusses on provisions to govern the professional relationship amongst the partners that is necessary for building a product or service, without focussing on profit shares or risk-taking abilities. Typically, it contemplates that the co-founders agree to come together and work on certain agreed principles to build a product / service. They may contribute certain financial sums for bearing the costs of the business.

From the moment that a clear revenue stream is imminent or profits are in sight, co-founders can contemplate two actions:
  • Entering into a formal partnership agreement which is much more detailed and registered with the Registrar of Firms (see the sample partnership agreement provided in the LMS)
  • Incorporating the business as an LLP or company. Key terms of the co-founders agreement can be incorporated into the LLP agreement or the company’s articles of association.
  • Amending the co-founders agreement to provide for more detailed provisions on profit sharing (and may be even operating bank accounts) and proceed for registration of the co-founders agreement as a partnership agreement with the Registrar of Firms so that there is certainty about its enforceability.
The co-founder’s agreement can state that if subsequently a formal legal structure is adopted for the venture carrying out the business, the co-founders will ensure that shares or mutual holding is as specified in the co-founders agreement.

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