You have a great idea that solves a huge problem in a sector you know. You have done the research, and are reasonably sure that everyone has absorbed it as well as the sales and marketing strategy. You are pretty confident that you and your co-founders are all aligned. You are have assumed that you can all agree on the share capital structure – well you are all friends after-all. You think you are clear on roles, responsibilities and accountability. You recall the conversation during which you all agreed how much you investing as pre-seed funding. You are clear that everyone is going to resign from their jobs next month to focus, especially as one person has a 12-month notice period to negotiate. The fact nobody is getting paid until you close the angel round was discussed over pizza a few weeks ago. You assume that everyone has obtained the buy-in of their significant others.
So, what could go wrong?
Everything, that's what.
Assumption Is The Mother of all F**k Ups
Having experienced numerous startups as a founder, professinal adviser, investor, or even as an observing friend of other founders, I have experienced many excited teams fall apart, and even old relationships crumble due to misunderstandings involving life-changing decisions. The wheels can fall off very quickly unless there is clarity during this periods of rapid change, risk and uncertainty. During my first week in investment banking, I was introduced to an important rule – ‘assumption is the mother of all f**k ups’. Don’t assume that the final version of the presentation you sent to the reprographics team at 4am, with that last important edit to the financial model overview page, is the one they printed and handed to you before you rush off to board a plane at 8am. Open the package and check it. Years of sometimes painful experience (such as landing in Basel, Switzerland with that hard copy presentation) has taught me how an assumption can ruin your day.
Why Do You Need to Agree?
Before you have constitutional documents drafted and sign up to a comprehensive shareholder agreement, which is what you should do, you need to agree? If anything, it will reduce your legal bill. In law, an agreement to agree is about as useful as a chocolate teapot. It doesn’t mean anything.
You need a reference point that you can refer back to should confusion arise or if somebody attempts to move a goal post. Don’t rely on conversations when one of the founding team couldn’t make it and assume that the person tasked to update them ever did. Put it in writing.
So far this year I have signed three documents like this. They might be headed ‘Binding Heads of Terms’ or a ‘Non-Binding Memorandum of Understanding’ – it doesn’t matter. Whether it is binding or not depends upon the message you want to convey, at what stage of development you are at and the seriousness of the sums, or risk, involved. Non-binding is more of a shared note. Binding is a contract. In most startup cases, you are never going to commence court proceedings if one of the parties decides not to leave their job or opens up a can of worms by requesting a larger slice of the equity. If you are remortgaging your houses, leaving well-paid employment and committing material capital, then a binding agreement may be necessary. The threat of legal action can focus minds. These documents are to shake out what you all think you have agreed.
What Do You Need to Cover?
The more detail, the better. Set it out as a letter from one of you to the others, or as something that looks like a commercial contract with a heading and sections. You may want some initial legal advice about what to include, and, eventually, the detailed document can be handed to lawyers as the basis for formal legal documentation. Each document will be specific to the circumstances, but here are some suggestions for the basics that need to be covered, in plain English:
Name the parties
Brief background and summary of the proposed business objectives
Roles - job titles are important to some
Responsibilities – who is going to do what and by when?
Ownership – shares and options and what happens if somebody leaves.
Investment to be made and when
Legal structure and any personal tax considerations
Intellectual property to be transferred
Then get everyone to sign it. If it is to be binding, this is important, but even if the document is non-binding, the signatories are more likely to think about its content before putting pen to paper.
You may have paragraphs that set out how you are going to ‘work together’ to do something ‘in good faith’. Such agreements to agree are almost impossible to enforce, but the principle has been set out. You can even split out which clauses are binding and which are not. For example, if somebody walks away, you may still want them to be bound by confidentiality.
Now, when a party complains that they thought they were going to be the CEO; or that they were putting less money in, but expected to have a more substantial shareholding due to time they have invested in planning, you have a reference point to go back to. You will have a record of what you had all agreed, and you can move forward, or not as the case may be, from there. This process also flushes out those that are not serious but want to tag along in case they miss out.
To protect even childhood relationships, don’t assume that you are all aligned until it is in writing.
Have you experience real and convenient misunderstandings? Has this advice made you think about putting a MOU together?
Please join my group. ScaleUp with Piers Linney, on LinkedIn.