Founders' Agreements: The Conversation That Shapes Success

Aug 26

14 min read

Updated: 1 day ago

Most founders have heard of a founders' agreement, often referred to as a shareholders' agreement, yet many businesses never take the step of putting one in place. Sometimes that is because legal costs can feel difficult to justify at outset of a new venture, when cash is tight. More often, however, it is because the conversations required to create one can be uncomfortable, particularly where the founders are friends, family members or long-standing colleagues.

That reluctance is understandable. In the excitement of launching a new venture, few founders want to discuss what happens if someone leaves the business, contributes less than expected, wants to sell their shares, or becomes involved in a dispute. Raising these issues can feel pessimistic when everyone is focused on growth and opportunity.

In reality, a founders' agreement is not about planning for failure. It is about having the difficult conversations early, while relationships are strong, expectations are aligned and there is no conflict to resolve. The decisions made at this stage are often the easiest, fairest and least emotional decisions a founding team will ever make.

Many of the disputes that damage or derail businesses do not arise because founders disagree on the vision. They arise because important issues were never considered or discussed in the first place. A well-drafted founders' agreement creates clarity, aligns expectations and provides a framework for dealing with challenges before they become problems.

In this article, we explore what a founders' agreement is, how it differs from a company's constitutional documents, and the key issues every founding team should consider at the outset. A quick note before we start

Founders' agreements sit at the intersection of company law and contract law. In the UAE, they also involve important decisions about legal structure and governing law. Before putting any agreement in place, founders should seek advice tailored to their specific circumstances.

This article is intended as general information only and should not be relied upon as legal advice.

It isn't the same as your company formation documents

When you incorporate a company in the UAE, you'll typically sign a Memorandum of Association (MOA) and, in many instances, Articles of Association (AOA).

These documents are essential, but they are not designed to regulate the day-to-day relationship between founders.

An MOA or AOA will generally record matters such as the company's shareholding structure and constitutional framework. In many cases, they follow a standard form provided by the relevant authority or free zone. They serve an important legal purpose, but they rarely answer the practical questions that often cause friction between founders as a business grows.

That's where a founders' agreement comes in.

A founders' agreement is a private contract between the founders themselves. It sets out how the founders intend to work together, how key decisions will be made, what happens if circumstances change, and how potential disputes will be dealt with.

In jurisdictions such as the DIFC and ADGM, many of these arrangements can be incorporated into bespoke constitutional documents. Elsewhere, they are more commonly contained in a separate founders' agreement or shareholders' agreement sitting alongside the company's incorporation documents.

Either way, the purpose is different. Your incorporation paperwork establishes the company. A founders' agreement helps protect the relationship between the people building it.

What should founders discuss?

Every business is different, but certain topics arise time and time again.

Roles and responsibilities

Who is responsible for what?

One of the most common mistakes founders make is assuming that everyone has the same expectations about their involvement in the business. In reality, founding teams often include people with very different roles and levels of commitment.

Some founders may be responsible for the day-to-day operation of the business, leading sales, product development, finance or operations. Others may contribute industry expertise, key relationships or strategic oversight. In some cases, a founder may contribute primarily capital and act more like a passive investor, without taking any active role in the management of the business.

There is no right or wrong approach, provided everyone understands and agrees to it from the outset.

A founders' agreement should clearly record who is expected to do what, how much time they are expected to commit, whether they will be employees, directors or simply shareholders, and what happens if those expectations change. For example, what happens if a founder who was expected to work full-time decides to step back after six months? Should their ownership position remain unchanged? Should their voting rights be affected?

Many founder disputes stem from one simple issue: a perceived mismatch between ownership and contribution. Having honest conversations about expectations early on can prevent significant tension later.

Equity and vesting

Agreeing who owns what is often one of the first conversations founders have, but it is rarely as straightforward as simply dividing the shares equally.

An ownership split should reflect not only who came up with the idea, but also the respective contributions each founder is making to build the business. Those contributions may include capital, industry expertise, intellectual property, business development capabilities, management experience, technical skills, or a commitment to work full-time in the business.

Founders should also think carefully about whether shares should be subject to vesting.

Vesting means that a founder earns ownership over time rather than receiving their entire shareholding unconditionally on day one. A typical vesting arrangement might provide for shares to vest over a three or four-year period, often with an initial "cliff" period before any shares vest at all. If a founder leaves early, some or all of their unvested shares can be repurchased by the company or the remaining founders.

The rationale is simple. If four founders each take 25% of a company and one leaves after three months, it can create significant resentment if that individual continues to hold a quarter of the business despite no longer contributing to its growth.

Vesting helps ensure that ownership remains aligned with ongoing commitment and contribution. It is also something prospective investors will often expect to see, particularly in venture-backed businesses.

Decision-making

Many founder disputes have nothing to do with bad behaviour and everything to do with a lack of clarity around who has authority to make decisions.

In the early stages of a business, founders often make decisions informally and by consensus. While that works when the business is small, problems can emerge as the company grows and decisions become more consequential.

A founders' agreement should clearly identify which decisions can be made by individual founders in their operational roles, which require majority approval and which require unanimous consent.

For example, founders may be comfortable allowing day-to-day commercial decisions to be made independently, while reserving matters such as issuing new shares, taking on debt, approving budgets, hiring senior personnel, selling key business assets or changing the nature of the business for collective approval.

Equally important is addressing deadlock.

Deadlock arises when a decision cannot be made because the founders cannot reach the level of agreement required under the founders' agreement. In a business with two equal founders, a disagreement on a fundamental issue can effectively bring decision-making to a halt. Even in larger founding teams, deadlock can arise where different groups of founders hold equal voting power.

There is no single solution. The appropriate approach will depend on the size of the business and the nature of the relationship between the founders. Common deadlock-resolution mechanisms include:

Escalation procedures, requiring the founders to meet and attempt to resolve the issue formally before other remedies become available.
Mediation, where an independent third party helps facilitate a resolution without imposing a binding outcome.
Expert determination, where a suitably qualified expert decides a specific technical or commercial issue.
Casting vote arrangements, giving one founder or an agreed independent director the final say on certain matters.
Buy-sell mechanisms, sometimes called "Russian roulette" or "Texas shoot-out" provisions, which allow one founder to offer to buy the other's shares at a specified price, with the recipient required either to sell at that price or buy the offeror's shares on the same terms.
Forced sale provisions, whereby the founders agree to sell the business if a fundamental deadlock cannot be resolved within a specified period.

Not every business requires sophisticated deadlock provisions, but every founding team should consider what happens if agreement becomes impossible. The objective is not to anticipate conflict but to ensure that the business can continue operating if conflict arises.

Good governance should not be viewed as bureaucracy. Clear decision-making frameworks allow businesses to move faster because everyone understands who has responsibility for what and which decisions require broader consultation.

Intellectual property

For many start-ups, intellectual property (IP) is the business.

The company's value may lie in its software, branding, product designs, proprietary processes, customer databases, content, trade secrets or other intangible assets rather than in any physical property.

One of the most common mistakes made by early-stage businesses is assuming that anything created by a founder automatically belongs to the company. In many cases, that is not necessarily true.

As a general rule, intellectual property initially belongs to the individual or entity that created it unless there is a legal arrangement transferring ownership elsewhere. This can create significant problems where a founder develops key technology, branding or know-how before incorporation or outside a formal contractual framework.

A founders' agreement should therefore make clear that all intellectual property developed for the business is assigned to the company and that the founders will take any additional steps necessary to document that transfer in the future.

Founders should also consider pre-existing intellectual property. For example, if a founder developed software, designs or proprietary content before joining the business, it may be necessary to identify whether that IP is being licensed to the company or transferred outright.

This becomes particularly important during investment rounds, acquisitions and due diligence exercises. Sophisticated investors and purchasers will often want evidence that the company's key intellectual property is properly owned by the company itself. Uncertainty in this area can delay transactions and reduce value.

In short, founders should assume that intellectual property ownership needs to be addressed expressly and not left to implication.

What happens if someone leaves?

A founders' agreement should also deal with what happens when a founder exits the business.

At the outset, nobody expects a founder to leave. In reality, departures happen for many reasons. Personal circumstances change, priorities evolve, founders fall ill, receive other opportunities or simply conclude that the business is no longer the right fit.

The key question is what happens to that founder's shares.

Many founders' agreements distinguish between good leavers and bad leavers.

A good leaver is typically someone who leaves under circumstances that are not considered harmful to the business, such as retirement, death, permanent incapacity, serious illness, or departure with the agreement of the other founders. A good leaver will often be entitled to retain some or all of their vested shares, or to receive fair market value for any shares that must be transferred.

A bad leaver, by contrast, may include a founder who resigns shortly after joining, breaches their obligations to the business, acts dishonestly, competes with the company, or is removed for serious misconduct. In those circumstances, a founders' agreement may require some or all of the departing founder's shares to be transferred at a discount to market value or, in some cases, at nominal value.

The precise definitions of good leaver and bad leaver need careful legal drafting, as the financial consequences can be significant.

How much are my shares worth? Determining how much a departing founder's shares are worth can be just as important as deciding whether they must be transferred.

Founders often assume that valuing a business will be straightforward. In practice, it is frequently one of the most contentious issues that arises when a founder leaves. This is particularly true for early-stage businesses, where there may be limited trading history, no profits and, in some cases, little or no revenue. A start-up may have valuable intellectual property, technology, market traction or growth potential, yet very little objective financial data on which to base a valuation.

For that reason, founders should consider agreeing a valuation mechanism at the outset, rather than attempting to negotiate one after a departure has occurred. By the time a founder leaves, relationships may have deteriorated and the parties may have very different views as to what the business is worth.

There are a number of approaches that can be adopted. For example, the founders' agreement may provide that the company's auditors or an independent valuation expert determine the value of the shares, that the valuation is calculated using an agreed formula, or that the parties obtain valuations from independent advisers and follow a prescribed process if those valuations differ. In some cases, different valuation methodologies may apply depending on whether the founder is a good leaver or a bad leaver.

Whatever approach is chosen, the objective is to provide a clear, fair and commercially workable mechanism that reduces uncertainty and avoids disputes at what can already be a difficult time for the business.

Founders should also consider pre-emption rights, which are often one of the most important protections in a founders' agreement.

Put simply, pre-emption rights generally require a founder who wishes to sell their shares to offer them to the existing shareholders first before selling to an external third party. This gives co-founders the opportunity to maintain control of the business and prevents an unknown outsider from acquiring an ownership stake without their consent.

Without pre-emption rights, a founder may be free to sell shares to anyone willing to buy them, potentially introducing a new shareholder whom the remaining founders have never met and do not wish to be in business with.

Alongside pre-emption rights, founders may also wish to consider related protections such as drag-along rights, tag-along rights and compulsory transfer provisions, all of which are designed to deal with future changes in ownership in a fair and predictable way.

The overall objective is not to plan for failure. It is simply to ensure that if circumstances change, there is already a clear and agreed process for handling the situation, protecting both the departing founder and those who remain.

Funding and dilution

Most businesses require additional capital at some stage, whether to hire employees, develop products, expand into new markets or simply manage cash flow during periods of growth.

Founders should discuss early on how future funding requirements will be addressed. While many businesses begin with founder-funded contributions, circumstances can quickly change as the company grows.

A founders' agreement can help clarify whether founders are expected to contribute additional capital if required, whether such contributions are voluntary or mandatory, and what happens if some founders are willing to invest further while others are not.

One area that is often misunderstood is dilution.

Dilution occurs when new shares are issued, reducing the ownership percentage of existing shareholders. This does not necessarily mean the value of a founder's holding decreases. In many cases, dilution accompanies growth in the overall value of the business. However, it does mean the founder owns a smaller percentage of the company than before.

A simple example illustrates the point. Imagine two founders each own 50% of a company. If the company later issues new shares to an investor in exchange for capital, the founders may each end up owning 40%, while the investor acquires the remaining 20%. Although the founders' percentage ownership has reduced, the investment may significantly increase the value of the business.

Founders should therefore think about how future share issuances will be approved and whether existing shareholders will have the right to maintain their ownership position.

This is where pre-emption rights on new share issues become important. These rights typically require the company to offer new shares to existing shareholders first before issuing them to external investors. This allows founders to participate in future funding rounds and maintain their proportional ownership if they wish to do so.

Founders should also consider how future employee share option plans may affect ownership. Many growing businesses reserve a pool of shares to incentivise key employees, which may dilute existing shareholders over time but can also play an important role in attracting and retaining talent.

Understanding funding and dilution from the outset helps align expectations and can prevent disagreements when investment opportunities arise. Conversations around raising capital tend to be far easier before the business urgently needs the money.

The UAE-specific consideration: choosing the legal framework

This is the part that often surprises founders who are setting up a business in the UAE for the first time.

Mainland UAE companies operate under the UAE's civil law system. By contrast, the DIFC and ADGM have their own common-law-based frameworks, with courts and regulations heavily influenced by English legal principles.

Why does this matter?

Many provisions commonly found in founders' agreements, such as vesting arrangements, drag-along rights, tag-along rights, good-leaver and bad-leaver provisions, and share transfer mechanisms, have developed through decades of common law practice and precedent.

That does not mean similar provisions cannot be implemented elsewhere. UAE company law has evolved considerably and offers businesses far greater contractual flexibility than in the past. However, the familiarity and predictability of a common law framework remains one reason why founders, investors and venture-backed businesses often favour DIFC or ADGM structures, or choose those jurisdictions as the governing law and dispute-resolution forum for their shareholder arrangements.

The right approach will depend on the nature of the business, where the founders are based, investor expectations and the wider corporate structure. It is not a decision that founders should make without advice.

Aligning with the company’s constitutional documents

Putting a founders' agreement in place is only part of the exercise. Founders should also ensure that the company's constitutional documents, particularly its articles of association, are reviewed and amended where necessary to align with the agreed position.

This is a step that is frequently overlooked. A founders' agreement may set out detailed rights, restrictions and processes, but if the articles of association contain inconsistent provisions, the result can be uncertainty, disputes and, in some cases, an inability to enforce the arrangements the founders thought they had agreed.

As a practical matter, the founders' agreement and the articles of association should work together as part of the same framework. The founders' agreement governs the relationship between the founders, while the articles regulate the company itself and are often the documents that third parties, investors, directors and courts will look to when determining how the company is to be operated.

Some common examples include:

Share transfers: A founders' agreement may provide that shares cannot be transferred without first offering them to the other founders. However, if the articles permit unrestricted transfers, the company may be obliged to register a transfer that was intended to be restricted.
Reserved matters: The founders may agree that key decisions, such as raising finance, issuing new shares or entering into significant contracts, require unanimous consent. If those protections are not reflected in the articles, the directors or a simple shareholder majority may have authority to proceed regardless.
Drag-along and tag-along rights: These provisions are commonly contained in founders' agreements, but unless the articles are amended to support them, practical enforcement can become more difficult when a sale process arises.
Founder departures: A founders' agreement may require a departing founder to transfer some or all of their shares under certain circumstances. If the articles do not contain compatible transfer mechanisms, implementing those arrangements can become unnecessarily complicated.
Board composition and voting rights: Founders may agree that each founder has the right to appoint a director or that certain board decisions require enhanced approval thresholds. Those rights should be reflected in the company's constitutional documents to avoid conflicting governance arrangements.

In short, a founders' agreement should not be viewed in isolation. Founders should take a holistic approach and ensure that all governance documents are aligned from the outset. Doing so creates a clearer roadmap for the business, reduces the scope for future disputes and helps ensure that the arrangements carefully negotiated at the start remain effective as the company grows.

Who should help with a founders' agreement?

Corporate service providers play an important role in helping businesses incorporate and obtain the necessary licences and registrations.

A founders' agreement, however, is something different.

It is a bespoke legal document designed around the specific circumstances of a particular founding team. It requires careful consideration of ownership, governance, incentives, intellectual property and future growth plans.

For that reason, founders should generally seek legal advice rather than relying solely on standard incorporation documents or template forms.

If a service provider suggests that the standard MOA or AOA provided during incorporation is all that is required, founders should take the opportunity to ask further questions about whether their commercial arrangements, governance expectations and shareholder protections have actually been documented.

Embrace the difficult conversation

Despite the legal terminology, a founders' agreement should not be viewed as an exercise in distrust.

The most productive approach is to treat it as a planning discussion.

Founders are not negotiating against one another. They are working together to create a framework that protects the business and preserves relationships if circumstances change.

Putting a vesting arrangement in place does not mean you expect somebody to leave. Agreeing a deadlock mechanism does not mean you anticipate disputes. Including good-leaver and bad-leaver provisions does not mean you doubt your co-founders' commitment.

These provisions are simply part of sensible business planning.

In my experience, founders who have these conversations early often end up with greater alignment and clarity. Everyone understands their role, their responsibilities and what happens if the unexpected occurs.

In summary

A founders' agreement is one of the most important documents a founding team can put in place, yet it is often overlooked in the excitement of launching a new business.

Unlike a company's incorporation documents, a founders' agreement is tailored to the specific relationship between the founders and the realities of how the business will operate. In the UAE, it also raises important considerations around legal structure, jurisdiction and governing law.

The key is to have the difficult conversations early. Founders should discuss and document matters such as roles and responsibilities, equity ownership, vesting arrangements, decision-making, intellectual property, founder departures, future funding requirements, dilution and dispute resolution while everyone remains aligned and focused on the success of the business.

More than just a legal document, a founders' agreement serves as a roadmap for the journey ahead, providing a clear framework for how decisions will be made, challenges addressed and opportunities pursued as the business grows.

These conversations can feel uncomfortable at the outset, but addressing them early is far easier than trying to resolve disagreements once a problem has already arisen. A well-drafted founders' agreement provides clarity, manages expectations and lays the foundations for long-term success.