Founders’ agreement: all the clauses that must be there from day one

Service page: Commercial contracts lawyer: drafting, review and enforcement.

What is a founders’ agreement, and where is it written?

A founders’ agreement is a contract between two or more people who set up a venture together, usually at a stage when there are still no investors, employees or revenue. No law requires you to sign such an agreement, and no law regulates it specifically. The clauses are set by agreement, against the background of company law, contract law and intellectual property law.

The understandings can be written in two places. The first is the company’s articles of association: a company may include in them the rights and duties of the shareholders and of the company, provisions on how the company is managed and on the number of directors, and any other matter the shareholders see fit to regulate in them (section 19 of the Companies Law, 5759-1999). The articles have the force of a contract between the company and its shareholders and among the shareholders themselves (section 17(a)). The second is a separate agreement between the founders, which binds whoever signed it.

The difference matters when a new shareholder joins, such as an investor or an employee who received shares: the articles apply to them too, while a separate agreement binds them only if they joined it. On the other hand, the articles can be amended by an ordinary majority at the general meeting, unless they set a different majority (section 20(a)), and the company may limit, in the articles or in another contract, its power to amend them, by a resolution passed by the majority needed to amend the articles (section 22(a)). So it is worth deciding, for each clause, whether it belongs in the articles, in the agreement or in both.

Splitting the shares: what to write beyond the percentages

The law does not say how shares are split between founders; that is a business decision. What is worth writing down is what lies behind the split, so that you can go back to it when something changes:

• How many shares, and of what class, each founder receives, and for what consideration.
• What each founder brings: money, working time, existing code or know-how, connections or customers.
• What happens in a future allotment to an investor or to employees: whether all the founders are diluted in the same proportion.
• Which decisions require the consent of all the founders, and who appoints the directors.

Shares are allotted by the company: the board of directors may issue or allot shares up to the limit of the registered share capital (section 288(a) of the Companies Law). In a private company, a shareholder is whoever is registered as such in the shareholders’ register (section 176), and the register records, among other things, the number and class of the shares and the date of allotment (section 130(a)(1)). An agreement on “half and half” that never reached the register can turn into a dispute over who is a shareholder, and with how many shares.

Vesting of shares: what happens to the shares of a founder who leaves

A founder who receives all the shares on day one and leaves after a few months remains a shareholder, even if they contributed nothing more to the company. Vesting is meant to tie the shares to a contribution over time. The terms come from founders’ agreements and investment agreements and do not appear in the law, and their content is set in the agreement:

• Vesting: the shares “vest” gradually over a period set in the agreement, on a monthly, quarterly or other schedule. A share that has vested stays with the founder even if they leave.
• Cliff: a first period at the end of which one portion vests. A founder who leaves before the end of the cliff has not accumulated any vested shares.
• Acceleration: early vesting of shares that have not yet vested, on an event set in the agreement: a sale of the company (Single Trigger), or a sale of the company followed by the end of the founder’s role (Double Trigger).

The mechanism can be built as “reverse vesting”: the founder receives all the shares at the start, and if they leave, the company or the other founders have a right to buy from them the shares that have not yet vested, at a price set in advance. It is worth also setting in the agreement what counts as leaving, whether there is a difference between leaving voluntarily, termination because of a breach, illness or death (Good Leaver / Bad Leaver), who buys, at what price and within how long.

When the company itself buys the shares, the law limits this. A purchase of the company’s shares by the company is a “distribution” as defined in section 1 of the Companies Law, and the company may make a distribution only under the distribution chapter of the Law (section 301(a)): out of its profits, provided there is no reasonable concern that the distribution will prevent it from meeting its liabilities (section 302(a)), or with the court’s approval when the solvency test is met (section 303(a)). In a young company that does not yet have profits, it is worth having the agreement also set who else may buy the shares, for example the other founders.

Roles, decision-making and deadlock

The agreement defines what each founder does, how much time they devote to the venture, whether and when they will receive a salary, and what happens when a founder does not do what they undertook. Alongside this, it sets who decides. Without a different provision, these are the default rules of the Companies Law:

• Resolutions of the general meeting are passed by an ordinary majority, unless the Law or the articles set a different majority (section 85).
• The directors are appointed by the annual general meeting, unless the articles provide otherwise (section 59).
• The general manager is appointed and dismissed by the board of directors, unless the articles provide otherwise (section 250).

When each of two founders has half of the voting rights, neither of them can pass a resolution alone. So it is worth writing down in advance a list of decisions that require the consent of all the founders, such as allotting shares, raising funds, selling the company and amending the articles, and a mechanism for deadlock: a structured conversation, mediation, an outside decision-maker or an exit mechanism.

Even when the agreement gives a founder a casting vote or a veto, using it is subject to the law. A shareholder must act toward the company and the other shareholders in good faith and in an accepted manner, and refrain from abusing their power, among other things when voting on an amendment of the articles (section 192(a)), and must also refrain from oppressing other shareholders (section 192(b)). A shareholder who knows that their vote will be decisive, and a shareholder who under the articles has the power to appoint or prevent the appointment of an officer, must also act fairly toward the company (section 193(a)). And when the company’s affairs are being conducted in a way that oppresses shareholders, the court may, at a shareholder’s request, give directions to remove the oppression, including directions that the shareholders, or the company subject to section 301, buy shares of the company (section 191(a)).

Intellectual property: who owns the code, the brand and the invention

The author of a work is the first owner of the copyright in it (section 33 of the Copyright Act, 5768-2007), and a computer program is a “literary work” for the purposes of the Act (section 1). Two provisions bear on this rule: in a work made by an employee for and in the course of their employment, the employer is the first owner, unless otherwise agreed (section 34); and in a commissioned work, the first owner is the author, unless the commissioner and the author agreed otherwise, expressly or by implication (section 35(a)). A contract to transfer copyright requires a written document (section 37(c)).

What this means for founders: code, design or text that a founder created before the company was set up, or while they were not its employee, does not necessarily belong to the company. So the agreement includes an undertaking by each founder to transfer to the company, in writing, the rights in what they created for the venture, and to sign any document needed to register the rights. It is worth attaching a list of what each founder brings with them, and stating what of it passes to the company and what stays theirs.

As for inventions, the Patents Law sets a rule for employer-employee relationships: an employee must notify their employer in writing of an invention they made as a result of their service or during the period of their service (section 131 of the Patents Law, 5727-1967), and an invention made as a result of their service and during the period of their service (a “service invention”) becomes the employer’s property if they have no other agreement, unless the employer waived it within six months from the day it received the notice (section 132(a)). When there is no agreement that sets whether the employee is entitled to consideration for a service invention, this is decided by the Compensation and Royalties Committee (section 134). These provisions may apply to a founder who is also an employee of the company, so it is worth having the agreement expressly settle the question of consideration too.

The brand name, the domain name and the accounts the product depends on, such as the code repository and the cloud services, should be registered in the company’s name and not in the name of one of the founders.

Exit mechanisms: right of first refusal, tag along, drag along and “buy or sell”

A company may set in its articles a provision that restricts the transfer of shares, on conditions it sets (section 294 of the Companies Law), and the company registers a share transfer in the register when it receives a deed of transfer signed by the transferor and the transferee and the requirements of the articles, if any, have been met (section 299(1)). The following mechanisms are built on this basis and on an agreement between the shareholders:

• Right of first refusal: a founder who wants to sell shares to a third party must first offer them to the other shareholders, on the same terms.
• Tag along: when a founder sells their shares, the others may demand that the buyer also buy their shares, on the same terms.
• Drag along: when shareholders who hold a percentage set in the agreement agree to sell, they may require the others to sell together with them. The details are in the guide Drag-along and tag-along: the drag right and the join right.
• “Buy or sell” (Shotgun, also called BMBY): one founder names a price per share, and the other chooses whether to sell them their shares at that price or to buy their shares from them at the same price. The mechanism assumes that both sides can finance a purchase; when that is not so, you can consider a different mechanism, such as a valuation by an outside appraiser.

Alongside the contract clauses, the Companies Law sets a route of forced sale in a private company: when the holders of 80% of the shares to be transferred have accepted a purchase offer within two months, the offeror may require the objectors to sell on the same terms, unless the court decided otherwise at the request of an objecting shareholder filed within a month of the notice (section 341(a)–(b)). The articles may set a different percentage (section 341(d)). And when exercising a right set in a contract, one must act in an accepted manner and in good faith (section 39 of the Contracts (General Part) Law, 5733-1973).

Non-competition and confidentiality: what can be restricted

A non-compete clause restricts a departing founder from working in a certain field, so it touches on a right that Basic Law: Freedom of Occupation protects: every citizen or resident of the State is entitled to engage in any occupation, profession or trade (section 3). The Basic Law binds the government authorities (section 5); in a contract between private parties, a contract whose content is contrary to public policy is void (section 30 of the Contracts (General Part) Law). The law does not set a permitted length or scope for such a clause.

A narrowly worded clause is clearer for both sides: for a defined period, for the company’s field of activity, and in connection with an interest the company needs to protect, such as confidential information, code and customers. An undertaking of confidentiality and of returning documents and materials at the end of the relationship stands alongside the clause and does not depend on it. On non-compete agreements in employment relationships, see Non-compete agreement: what is valid and what is not in Israel.

Clause outline for a founders’ agreement (to copy)

The outline puts the topics on this page in order, with square brackets to fill in. It is not a ready-made agreement: each clause has to describe what the founders actually agreed.

When not to rely on the outline alone

• An investment agreement, a SAFE or a convertible loan has already been signed or is about to be signed: these documents sometimes deal with the same topics, and you need to check that they do not conflict.
• One of the founders still works for another employer, or developed the idea while working there: an invention an employee made as a result of their service and during the period of their service becomes the employer’s property, unless they have a different agreement (section 132(a) of the Patents Law), and it is worth checking their employment contract too.
• There are shares of different classes, unequal holdings or veto rights: an amendment of the articles that harms the rights of a class of shares also requires the approval of a meeting of that class, unless the articles provide otherwise (section 20(c) of the Companies Law).
• The company is being incorporated outside Israel, or one of the founders is not an Israeli resident: a different law may apply.
• The allotment of shares, vesting and buy-back may have tax consequences, and these are worth checking before signing, not after.
• There is already a dispute between the founders, a founder has announced that they are leaving, or the shares were already allotted without an agreement.

Frequently asked questions

Do you have to sign a founders’ agreement?

No. No law requires you to sign a founders’ agreement. Without an agreement, the relationship between the founders is governed by the company’s articles of association, which have the force of a contract between the company and its shareholders and among the shareholders themselves (section 17(a) of the Companies Law), and by the provisions of the Companies Law. For example, resolutions of the general meeting are passed by an ordinary majority, unless the Law or the articles set a different majority (section 85). The agreement lets you decide in advance on what the law does not regulate: vesting, roles, intellectual property and exit.

What is the difference between a founders’ agreement and the company’s articles of association?

The articles bind the company and all the shareholders, including whoever joins in the future (section 17(a) of the Companies Law), and they can be amended by an ordinary majority at the general meeting, unless they set a different majority (section 20(a)). A founders’ agreement binds whoever signed it, and changes as it provides. So it is worth deciding, for each clause, whether it belongs in the articles, in the agreement or in both.

What are vesting and a cliff in a founders’ agreement?

Vesting is a mechanism in which a founder’s shares “vest” gradually over a period set in the agreement. A cliff is a first period at the end of which one portion vests, and a founder who leaves before it ends has not accumulated any vested shares. The terms do not appear in the law, and their content is set in the agreement. When the company itself buys back shares that have not vested, the purchase is a “distribution” (section 1 of the Companies Law), and it is subject to the distribution rules in sections 301–303.

Does the code I wrote before we set up the company belong to the company?

Not necessarily. The author of a work is the first owner of the copyright in it (section 33 of the Copyright Act), and a computer program is a literary work for the purposes of the Act (section 1). Code written before the company was set up remains the property of whoever wrote it until it is transferred to the company, and a contract to transfer copyright requires a written document (section 37(c)). So a founders’ agreement includes a clause that transfers the intellectual property to the company.

Can a departing founder be required not to compete with the company?

A non-compete clause can be included in the agreement, but it touches on freedom of occupation: every citizen or resident of the State is entitled to engage in any occupation, profession or trade (section 3 of Basic Law: Freedom of Occupation), and a contract whose content is contrary to public policy is void (section 30 of the Contracts (General Part) Law). The law does not set a permitted length or scope for such a clause, so it is worth wording it narrowly: for a defined period, for the company’s field of activity, and in connection with the information or customers it is meant to protect.

What happens when two founders who hold 50/50 disagree?

When each of two founders has half of the voting rights, neither of them can pass alone a resolution that requires an ordinary majority (section 85 of the Companies Law). So it is worth setting in the agreement in advance a mechanism for deadlock, such as mediation, an outside decision-maker or a “buy or sell” mechanism. When the company’s affairs are being conducted in a way that oppresses shareholders, the court may, at a shareholder’s request, give directions to remove the oppression (section 191(a)).