By: Katelyn J. Dougherty, Esq.

When starting a business, it’s crucial to establish clear legal frameworks to ensure the smooth operation and future growth of the enterprise. Two critical documents often considered by business founders are the Founder Agreement and the Operating Agreement (or a Shareholders Agreement for a Corporation). Understanding when and why to use each can be pivotal in setting the right legal foundation for your company.

Founder Agreement: Laying the Groundwork

When It’s Needed: A Founder Agreement is most relevant during the early stages of a startup, particularly when the business is in its conceptual or developmental phase. This agreement is crucial when there are multiple founders involved.

Key Elements of a Founder Agreement can include:

• Ownership and Equity Distribution: It outlines how equity is divided among the founders, which is especially important before any significant value is created.
• Roles and Responsibilities: Clearly defining who is responsible for what can prevent conflicts later.
• Decision Making: It sets the rules for how decisions are made, including voting rights and majority rules.
• Conflict Resolution: Provides a framework for resolving disputes among founders.
• Exit Strategy: Outlines procedures for a founder’s exit, whether voluntary or involuntary.

Operating Agreement: Structuring Operations

When It’s Needed: An Operating Agreement comes into play when the business is more established and typically when it’s registered as a Limited Liability Company (LLC). It’s vital for clearly defining the operational and financial decisions of the business, including rules, regulations, and provisions.

Key Elements of a Operating Agreement can include:

• Management Structure:  Outlines the management structure and how the business is run, whether member-managed or manager-managed.
• Capital Contributions: Details about the investments made by each member.
• Profit and Loss Distribution: How profits and losses are shared among members.
• Voting Rights: Defines the voting power of each member, often based on their percentage of ownership.
• Membership Changes: Procedures for adding new members or handling the departure of existing members.

Choosing the Right Agreement

It’s not a matter of choosing one over the other; rather, it’s about understanding the right time to implement each agreement.

Start with a Founder Agreement: When your business is just a concept or a startup in the early stages, a Founder Agreement is essential. It lays the groundwork for how the founders will interact and manage the early stages of the business.

Shift to an Operating Agreement: As your business grows and becomes more structured, particularly if forming an LLC, an Operating Agreement becomes necessary. It provides the legal framework for managing the company’s operational and financial aspects.

Legal Assistance

Both agreements are legally binding and have significant implications for the business’s future. Therefore, it’s advisable to seek legal counsel when drafting these documents to ensure they are comprehensive and tailored to your specific business needs.

Conclusion

In summary, both Founder Agreements and Operating Agreements play vital roles at different stages of a business’s lifecycle. Start with a Founder Agreement to set the foundation among the founders, then transition to an Operating Agreement as your business grows and requires more defined operational structures. With the right legal frameworks in place, you can focus on growing your business with confidence and clarity.

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This Blog was written by Founding Attorney, Katelyn Dougherty.

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