There's one common mistake that I have seen a lot of founders make.

Or something they don't understand the difference between.

I am talking about the Co-Founders Agreement and Shareholders Agreement here.

In this Newsletter, I will help you understand what these actually are and why they are important to you.

I always talk about how common it is for Founders and other stakeholders to get into a dispute amongst themselves.

Whatever the disputes might result in, the inception of the dispute itself is stressful for all.

That's why there must always be some sort of formal arrangements in place to:

(1) Anticipate these scenarios which are way too common

(2) Avoid these cases or at least have a solution to them when they arise

That’s where Agreements come into the picture.

And in particular, I am talking about 2 Agreements here:

(1) Shareholders Agreement

(2) Co-Founders Agreement

These two agreements are often treated as one and the same - and yes, broadly speaking, they are very similar.

The purpose of both of these agreements is to agree on different subject matters such as:

(a) Management

(b) Equity

(c) Ownership

(d) Rights and responsibilities of stakeholders in the Company

So let me share with you what these agreements are.

And when you should get them to begin with!

And why you would need them! :)

Co-Founders Agreement vs Shareholders Agreement

1) Co-Founders Agreement:

As the name suggests, it is signed between the Founders or the founding team of the Company or business venture.

It decides on a few important areas:

a) Equity Allocation:

It decides who owns what percentage of the company once it's officially formed.

b) Vesting Period: 

It also mentions when each founder will gain control over their equity.

This avoids issues of if someone decides to leave early.

c) Dispute Resolution:

One of the main ones.

It also outlines the ways you can handle disagreements among founders.

And this is super important for early-stage startups because you want to keep the core team together.

And also address what happens if someone wants to leave.

Ideally, you should draft the Co-Founders Agreement even before formally incorporating the business.

Especially if you're not planning to set up a formal business structure right away.

2) Shareholders Agreement

The Shareholders Agreement is usually signed when there are multiple shareholders in the Company.

These can include Founders, or third parties who have obtained shares from founders, or Investors.

It focuses on two main parts:

a) Relationship Details:

It focuses on the relationship between the shareholders, including the investors.

And deals with matters such as Voting Rights, Restrictions on Share transfers, Dividend Policies, management and governance matters, and even Dispute Resolution.

b) Organized Management:

The goal of a shareholders agreement is to run the business in a more organized and professional manner.

For e.g., you don't want any random third party coming in as a shareholder without notice to others.

Unlike the Founders Agreement, the Shareholders Agreement comes into play at a mature stage.

Typically, when the investors or other third parties join as shareholders.

The Name Does Not Matter

With that being said, the name of the document does not really matter.

They are quite similar. 

What matters is the Content of the Agreement, which is the clauses.

For example, an Employment Agreement named a Service Agreement does not make the relationship of a Contractor between the parties.

Because the content of the agreement mentions and shows it's an employer-employee relationship.

And that's what's looked at in the end.

That's it!

The documents might overlap, but that's why understanding the purpose of forming them becomes important.

To give you a brief idea again:

(1) Founders Agreements cover your company FROM formation to your first equity funding round.

They are important for reducing risks associated with the business relationship between co-founders.

(2) Shareholders Agreements come into effect FROM the first equity funding round.

Basically, when you have external investors as shareholders and replace the Founders Agreement at that point.

I hope the difference makes more sense now!

See you this Sunday with a Case Study now! 🙂 

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