Introducing the Founder Accord
With an impressively steady volume of new company formations, we have seen numerous variations on a few simple themes:
- Companies begin as ideas, and it is not immediately clear whether an idea can really become a viable business. Figuring that out takes time and effort.
- Many entrepreneurs are involved at various levels with several "idea stage" projects simultaneously.
- People tend to collaborate informally, but use (or understand) official/legalistic sounding words to describe these collaborations.
- The collaboration process is more democratic. People no longer only start companies with college or work colleagues. Plenty of companies are started by people who met recently at a meetup or similar event (and thus do not know one another extremely well).
- It is not always practical to complete the legal formalities of forming, organizing and capitalizing a company every time that you have a good idea (and once you form a company, you are stuck with it, including ongoing obligations for tax filings, etc., even if the company is not profitable).
- No one wants to get screwed because they did not "do it the right way" from the very beginning.
Eduardo Saverin and Reggie Brown are two of the higher profile cautionary tales of this problem, but every year, we hear a handful of accounts similar to this one. We were contacted after the fact by an entrepreneur who had assisted two founders of a fledgling technology company. He started out doing some "consulting" for them, but shortly became effectively (but informally) the "third founder" of the company, assuming the role of the Company's head of business development. In this capacity, he told us, he introduced the company to several high quality business leads who eventually became significant paying customers. Through a series of e-mails and conversations, they sketched out what he believed to be an allocation of a pre-financing equity stake in the Company. Needless to say, this story did not end well for him. When the company received its first financing, his partners re-cut his equity deal (to his significant detriment) and sent him a bunch of long form legal documents to sign that memorialized the less generous, far more contingent offer, with his equity priced much closer to the impending financing round than the (near zero) price the other founders afforded themselves. This created a dilemma for him. If he signed, he would effectively be agreeing to the revised (and much worse) deal; if he did not sign, he could end up with nothing, and would then have to hope that his e-mail exchanges created a legally enforceable agreement.
Beyond the philosophical observation that experience is only gained at the price of adversity, the macro point is that to maintain a vibrant entrepreneurial community, there should be an effective way to balance the practicalities of the company and capital formation process and the reality that legally enforceable agreements should be thorough and in writing. If the proverbial handshake (or, in today's world, e-mail thread) deal creates more risk than opportunity, then you will adapt your behavior in one of two ways. You will either hold back (and be hesitant to contribute "too much" to a new project where your benefits are uncertain) or you will simply not bother with the project. In the first instance, if everyone adapts in the same way, then the result will be a "false negative" (a good idea that goes nowhere because the creators do not devote the necessary effort). In the second instance, the idea never gets off the ground. Either way, everybody loses.
With all of the above in mind, we are pleased to present our solution – the Founder Accord. This is a simple, plain English, short document that lays out the most basic structure for collaborating on a new idea or project that may develop into a company.
What it does
The Founder Accord is intended to provide entrepreneurs with the comfort they need to take risks while sparing them the effort and expense required to complete a customary corporate formation and capitalization before knowing that they actually have a viable business – or have even formed a company. The Founder Accord can be more or less detailed depending on the particulars of the project and the parties involved. Some will opt for more details (milestones, contingencies, etc.); others, for less. If experience is any guide, at the very least a Founder Accord should be signed by all relevant players and should memorialize the agreed upon equity split (and maybe any conditions or contingencies regarding founder equity). These two steps alone may well resolve some of the most contentious feuds among company founders (see above). Another important benefit is that it sets expectations among the founders as to each person's respective time and professional bandwidth commitment to the project. Finally, hashing out a Founder Accord over the course of a few hours can be a useful and important team building exercise, particular where not all of the founders know one another well.
What it does not do
A Founder Accord should not be viewed as a substitute for the long form legal documents that would memorialize the points sketched out in it (any more than, say, a term sheet is a substitute for customary financing documents). We would thus caution against trying to address every imaginable issue or detail in a Founder Accord. Also, while a Founder Accord may alleviate the need to actually form a company at too early a stage, it is important to consider that without a separately incorporated vehicle (a corporation or an LLC), the Founders are without the legal protections (e.g., limited personal liability) afforded by incorporation. As a result, the Founders could be viewed as general partners, who can be held jointly and severally liable for the obligations of their partnership. Accordingly, a Founder Accord is a temporary fix at best – the intermediate step between the proverbial handshake and stack of legal documents. It may help to create the conditions necessary to set the larger company formation process in motion, but it is not a substitute for that process.
Toward a(second best)n Industry Standard
To maximize the industry – and legal -- value of using a Founder Accord, we are encouraging a push for industry-wide adoption. Over time, if the Founder Accord is recognized as an industry standard for early stage company formation, it can become a credible basis for the claims spurned founders. Conversely – and of perhaps greater use – it can protect legitimate founder teams from "opportunistic" sorts coming out of the proverbial woodwork after a company thrives (since in a world where all legitimate founders executed a Founder Accord, a claimant who did not would have some explaining to do). As an industry standard, the Founder Accord remains second best (http://a.sarva.co/the-elite-ethic/#comments), but it may serve to enable greater cooperation among members of an open community that is in an intentional state of continuous motion.