The Importance Of A Founder Agreement

About Founders Agreements

One of the first steps for individuals working together as co-owners of a contemplated new business is to enter into a written agreement about the contemplated business.

Under California law, the association of two or more persons to carry on a business for profit as co-owners forms a partnership, whether they intend to operate the business as a partnership or not ¹. Accordingly, before a separate legal entity like an LLC or corporation is formed (if ever) to carry on the business, the individuals working together as co-owners of a business for profit will operate as a partnership under California law.

It is important to note that the starting point of “carrying on a business for profit” is not necessarily when the business starts selling its products or services. At least for U.S. tax purposes, someone is legally engaged in a business enterprise when they engage in an activity with the actual and honest objective of making a profit. Before a business starts selling, a significant investment (time and money) is often made to create the business. Commencing these activities, therefore, often marks the start of “carrying on a business for profit.” Accordingly, a partnership will typically arise between individuals long before any sales are actually made.

Under California law, a partnership agreement governs the relations among the partners and between the partners and the partnership. A “partnership agreement” may be written, oral, or implied among the partners concerning the partnership. “Founders Agreement” is a general term that refers to the partnership agreement between co-owners (i.e., co-founders) of a business enterprise. It typically precedes the formation of a separate business entity, such as an LLC or corporation, to carry on business operations.

While a partnership agreement in California may be oral or implied, it is generally always best to have a written partnership agreement that clearly establishes things. In California, to the extent a partnership agreement does not otherwise provide, the California Uniform Partnership Act (CUPA) provisions will govern the relations among the partners and between the partners and the partnership. This may not lead to the intended or best results for the individual co-owners of a business.

It is very important that the founders of a business enterprise have a thorough conversation at the start to address the issues of going into business together. The product of such a conversation should then be reduced to a written and executed founders agreement, which will govern the partnership until the business ceases or is transferred into a different business entity, like an LLC or corporation.