Founders Agreement

What is a founders agreement?

Founders agreement (also called a founders' contract) is the contract in which the founders of a company set out the basis of their cooperation before or at the time of formation. It typically governs roles, time commitment and the distribution of the shares, vesting (the gradual earning of shares over several years) and the consequences of an early departure. Added to this are rights to the product, non-compete clauses and rules for joint decisions. The agreement is concluded while everyone is in agreement; it shows its value when a dispute arises later or a founder leaves.

The agreement usually comes into being while the founders are working towards the notarial formation of a GmbH (German limited liability company); in this phase they generally already form a partnership under the German Civil Code (Gesellschaft bürgerlichen Rechts, a pre-formation partnership). After formation, it applies as a shareholders' agreement alongside the articles of association, the notarised partnership agreement of the GmbH. Unlike the articles of association, it is not published in the commercial register and binds only the signatories (contractual effect). In the first funding round with professional investors, it is usually superseded by a new shareholders' agreement concluded together with the participation agreement.

Contents of a founders agreement

Roles, time commitment and management

The agreement sets out who takes on which tasks, who works full time and who is to become managing director. The shareholders' meeting resolves on the appointment, and under Section 38(1) of the German Limited Liability Companies Act (GmbHG) it can in principle be revoked at any time. The founders agreement itself can only regulate how the founders vote on appointment and removal. If removal is to be restricted to good cause, this has to be in the articles of association (Section 38(2) GmbHG).

Distribution of the shares

There is neither a statutory rule nor a generally customary split. What counts is past contributions, the future role, contributed capital and the waiver of market-standard pay in the start-up phase. A later correction requires notarised assignments and may have tax consequences.

Vesting and leaver rules

Founders hold their shares from formation. Vesting is therefore structured in reverse: if a founder leaves before the agreed period has expired, he or she must give up the part of the shares not yet earned. This is implemented through acquisition rights of the co-founders or through redemption. In a redemption, the share is cancelled by shareholder resolution against compensation; it is permitted only if the articles of association provide for it (Section 34(1) GmbHG). A buy-back by the company itself is possible only to a limited extent, because it may pay for fully paid-up shares only out of assets above the share capital (Section 33 GmbHG). The price depends on whether the founder leaves as a good leaver or as a bad leaver.

Contribution of rights

Software, graphics, domains and trademark applications created before formation initially belong to the founders personally. The founders agreement obliges them to procure these rights for the company. Trademarks and domains are transferred. For software and graphics this is not possible, because copyright itself is not transferable; the company receives exclusive rights of use there, that is, the sole right to use the works. Proper implementation (IP assignment) is a fixed checkpoint in every later transaction.

Non-compete and confidentiality

The GmbHG does not provide for a non-compete for shareholders (non-compete clause). It has to be agreed and is permissible under competition law only to the extent that it is necessary in subject matter, territory and time to protect the joint company. A ban for the duration of the shareholding and a limited time afterwards is common. Founders in management are in any case subject to a non-compete during their term of office, arising from their fiduciary duty as an organ of the company. For the period afterwards, a separate agreement is needed (non-compete agreement).

Decision rules and deadlocks among founders

Under Section 47(1) GmbHG, shareholder resolutions require a majority of the votes cast; if the votes are tied, a motion is rejected. Two founders with 50% each can therefore not pass a resolution against the will of the other. In the event of fundamental disagreement, a deadlock arises: without good cause, neither can a managing director be removed nor a budget or financing resolved. Founders agreements provide tiered mechanisms for this:

• Escalation and mediation: first a structured conversation between the founders, then a mediator with a fixed deadline.
• Casting vote: The founders undertake, in the event of tied votes, to vote as an advisory board or a previously named person of trust decides, limited to defined topics.
• Separation mechanism: as the last stage, a shotgun clause, under which one founder names a price per share and the other chooses whether to sell at that price or buy.

A separation mechanism works only if both founders could finance the purchase. If one has significantly more liquidity, he or she can name a low price: the other cannot buy at that price and has to sell.

Form and notarisation of the founders agreement

A founders agreement is in principle effective without any particular form. This changes as soon as it contains an obligation to assign shares: it then requires notarisation under Section 15(4) GmbHG. This covers obligations to transfer back arising from vesting, acquisition rights in leaver cases, rights of first refusal and drag-along obligations, that is, the obligation to sell one's own shares along with others in a sale. A contract that binds the parties to form a GmbH is also, according to case law, subject to notarisation.

Notarisation extends to all arrangements that form a single transaction with the obligation requiring form. If the form is missing, the obligation is void, and depending on its design the entire agreement may be invalid (Section 139 of the German Civil Code, BGB). The defect is cured only by the assignment itself made in the proper form (Section 15(4) sentence 2 GmbHG). In practice, the founders agreement is therefore notarised together with the formation or immediately afterwards.

The founders agreement in funding rounds and due diligence

Investors ask for the founders agreement early. It shows whether the founders are bound, whether the rights to the product lie with the company and whether the cap table (the overview of all holdings) shows shares without any contribution of work. In due diligence, the agreement, deeds, articles of association and list of shareholders are reconciled with one another.

In the round, founder vesting is usually renegotiated. Investors often credit the time elapsed since formation in whole or in part, and a new plan applies for the rest. For tax purposes, Section 7(7) of the German Inheritance and Gift Tax Act (ErbStG) must be observed. If a founder leaves the company entirely and the compensation is below the tax value of the shares, the difference is treated as a gift to the remaining shareholders. Whether a transfer back below value by a founder who remains a shareholder also falls under this belongs in the tax review beforehand.

Worked example: vesting in the founders agreement

Three founders form a GmbH with share capital of EUR 30,000, divided into 30,000 shares of EUR 1 each. Founder A and founder B each take 12,600 shares, and founder C takes 4,800 shares. The notarised founders agreement provides for vesting over 48 months. Before a cliff of twelve months has passed, nothing counts as earned; after that, the earned part grows monthly. In the good leaver case, unearned shares are to be assigned at nominal value, here EUR 1 per share, to the remaining founders in proportion to their holdings. C leaves as a good leaver after 30 months.

• Holding before the departure: A and B 12,600 / 30,000 = 42% each, C 4,800 / 30,000 = 16%
• Earned by C: 30/48 of 4,800 = 3,000 shares
• Not earned: 4,800 minus 3,000 = 1,800 shares
• Assignment to A and B in the ratio 12,600 to 12,600: 900 shares each
• Purchase price at nominal value: 1,800 × EUR 1 = EUR 1,800, of which EUR 900 each from A and B
• Holding afterwards: A and B 13,500 / 30,000 = 45% each, C 3,000 / 30,000 = 10%

The assignment is notarised. In relation to the company, A and B count as holders only once the new list of shareholders has been entered in the commercial register (Section 16(1) GmbHG). Little changes in the majorities: A or B together with C still form a simple majority afterwards (45% plus 10% = 55%). The real effect is economic. Without an effective obligation to transfer back, C would remain a 16% shareholder even though he no longer works in the company. In a later sale, he would then receive the proceeds for 16% instead of 10% of the shares.

Distinction: founders agreement, articles of association and shareholders' agreement

• Partnership agreement (articles of association): the publicly accessible constitution of the GmbH, which also binds future shareholders. The founders agreement supplements it confidentially.
• Shareholders' agreement of a funding round: takes over the core points of the founders agreement and adds investor rights such as consent reservations, tag-along rights and rules for the exit.

Common mistakes

• Vesting without notarisation. Obligations to transfer back in an agreement signed only privately are void for lack of form and cannot be enforced against a departing founder.
• Equal shares without a conflict rule. With two founders at 50% each, fundamental disagreement blocks the shareholders' meeting as long as no mechanism for deadlocks has been agreed.
• Contradiction with the articles of association. If grounds for redemption, transfer restrictions (Vinkulierung, a duty to obtain consent for share transfers) or majorities differ between the articles of association and the founders agreement, it is unclear in a dispute which rule prevails.
• Vague leaver definitions. Without a clear distinction between good and bad leaver, the dispute arises at exactly the moment a founder leaves the company.

Frequently asked questions

Does a founders agreement have to be notarised?

Not in every case, but in practice almost always. As soon as the agreement contains obligations to transfer shares, for example from vesting, leaver rules or rights of first refusal, notarial form is mandatory under Section 15(4) GmbHG. Without such obligations it remains free of form, but then forgoes its most effective instruments.

Is there a template for a founders agreement?

Templates exist, but they are only useful as an outline. English-language templates from the US or UK market are tailored to the corporate law there and reflect neither the GmbH articles of association nor the notarisation requirement under Section 15(4) GmbHG. Anyone who translates such a template and signs it only privately easily ends up with obligations to transfer back that are void for lack of form.

What happens to the founders agreement in a Series A round?

As a rule, it is superseded by the new shareholders' agreement that all shareholders, including the investors, sign in this first larger round. Individual rules, for example on vesting, are taken over and adjusted; the rest are replaced by the new contract.

Does the founders agreement also apply to shareholders who join later?

Only if they accede to it. As a contract under the law of obligations, it binds only the signatories. It therefore often provides that shares may be transferred only to acquirers who accede to the agreement; the articles of association secure this through transfer restrictions.

The Roemer Capital view

Before we approach investors in a financing mandate, we read the founders agreement together with the articles of association, the list of shareholders and the cap table. We check whether vesting and leaver rules are notarised and aligned with the articles of association, and whether the rights to the product lie with the company. We also record the shares of former co-founders who no longer work in the company. Open points go to the company's law firm before investors get access to the data room.

In the round, we prepare on the economic side how the existing founder rules are carried over into the new shareholders' agreement, for example which vesting time is credited and which leaver prices should apply. For us, an orderly founder base is part of governance, one of the four pillars that show whether a company is investor-ready.