Dana Ben-Yehuda

When a group forms to establish a joint venture, the first legal document they should draft is a founders’ agreement. The purpose of this agreement is to define the conditions under which the entrepreneurs will establish a startup together. A founders’ agreement regulates the rights and obligations of the founders inter se and the rights and obligations between them and the company.

Founders’ agreements determine and regulate various types of provisions, commitments, and rights. It is highly recommended not to waive such an agreement. A good agreement may help you avoid conflicts and disputes later on. It is also extremely important to hammer out several issues before embarking on a joint venture and, at the very least, before drafting the founders’ agreement.

Crucial Points

When Should You Sign a Founders’ Agreement?

The question of when to sign a founders’ agreement has no unequivocal answer. One possibility is when you feel that the venture is becoming serious. This can happen at various stages in any venture. When the moment comes, it’s important to know where you are heading and what contingencies you may face.

Share Distributions

When forming a company, each founder receives shares of the company. The quantity of shares will determine each founder’s shareholding ratio and control over the company. Although it is customary for all founders to hold the company in equal shares, sometimes, when one founder’s contribution to the company is less than the others (for example, the founder is only involved in the venture on a part-time basis), then you may decide that fewer shares will be allotted to that founder. Keep in mind that the founders’ holdings are diluted during future investments as a result of share allotments to new investors. As a result, the founders’ shareholding ratios diminish proportionately.

The Right to Appoint Directors

The board of directors sets the company’s strategy and is the most important governing body in the company. The right to appoint a director enables a shareholder to have some control over the company’s management. It is customary to define that every founder will have a right to appoint one director. No less important is setting rules defining when the right to appoint a director is revoked, in order to avoid a situation whereby a founder who leaves the company retains a right to vote on the board of directors.

Roles

Another topic the founders’ agreement regulates is the division of roles in the company and the founders’ level of engagement with the company. It is important to decide the division of roles and responsibilities in the company even before establishment. This is to create order and enable the company to function optimally. By agreeing to this in the founders’ agreement, every founder knows his role and his spheres of responsibility.

Involvement

It is very important to decide every founder’s degree of involvement in the venture’s activities. Sometimes, at the outset of the collaborative work, some of the founders still hold other positions. It is important for the founders to realize that, as soon as they decide to proceed with the venture, they have to decide the extent of involvement expected from each founder. This decision has a major impact on the venture's success and future investments.

Intellectual Property

In most cases, founders begin working on the venture before establishing the company. Therefore, it is important to add a clause in the founders’ agreement that regulates ownership of intellectual property, whereby the founders covenant that they will transfer all of their intellectual property rights to the company’s ownership immediately upon its establishment. This also has an impact on the future of the company. If it becomes evident later on that a founder that left the company owns some of the company’s intellectual property, this could constitute grounds for a lawsuit and also adversely impact future investments in the company.

Investments

If development of the venture depends on funding even before the initial fundraising, for example, to hire professionals to develop the product or to purchase materials, software, and computers, it is advisable to decide whether each founder needs to invest money in the company and, if so, at what volume. It is also important to define the classification of the funds invested in the company. Possible classifications include a shareholder’s loan the company will have to repay in the future or seed money entitling the founder to an additional allotment of shares.

Reverse Vesting

One of the most important topics in a founders’ agreement is regulating the scenario whereby one of the founders decides to leave the company or, alternatively, the founders collectively decide one of them has to leave. The customary practice is to include a “reverse vesting” clause in the founders’ agreement. According to this mechanism, if one of the founders leaves the venture or company, then some (or all) of that founder’s rights in the venture transfer to the other founders, or return to the company. The percentage of rights the exiting founder retains usually depends on the time frame and the scope of his contribution to the venture.

Many consider this mechanism as a fair mechanism that balances between a founder’s right to retain a share of the venture that he helped establish and that provides the other founders with higher percentages of the venture because they are proceeding without the exiting founder (and because they may need to grant shares to a new entrepreneur).This mechanism must specifically address various scenarios, such as what happens if a founder does not achieve the milestones in the venture that were defined for him, or what happens if one of the founders becomes disabled or dies.

Non-Compete

During the collaborative work on the venture, the founders gain access to the venture’s ideas, knowledge, and professional secrets. Therefore, it is customary to add a non-compete clause to founders’ agreements. This clause restricts any exiting founder’s use of the venture’s confidential know-how and information and prevents any adverse impact on the venture’s competitive advantage in the market. As a rule, non-compete stipulations are problematic because they infringe on a person’s freedom of occupation. However, the courts recognize this stipulation in particular instances, including when the parties are partners in the venture and have a shared interest in protecting it.

Articles of Association

A company’s articles of association legally bind all of the company’s shareholders. This differs from a founders’ agreement, which is legally binding only on the founders who signed it. Since the founders are the company’s first shareholders, the founders’ agreement can stipulate that the provisions relating to the founders as shareholders will later be included in the company’s articles of association, such as the drag-along right, the preemptive right, or the right of first refusal.

It is important to keep in mind that a founders’ agreement includes many additional provisions that require the expertise of an attorney specializing in high-tech. Every company is unique and complex and the agreement must be tailor-made for it. Although this agreement is legally binding only on the founders, founders should not underestimate its importance. Indeed, founders’ agreements can have an enormous impact on the future of the company and even on its success. 

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Barnea Jaffa Lande's Corporate Department is at your service for questions regarding founders’ agreements and other related issues.

Adv. Dana Ben Yehuda is an associate in the firm's Corporate Department. 

Israel has become a hub for extensive international business activity in recent decades. Israel’s economic growth, coupled with state encouragement (including acting to reduce the regulations and taxation on corporations), enable local and international businesses to engage in business activity easily and with relative efficiency.

There are several alternatives for incorporating an entity in the State of Israel. The most common alternative is forming a limited liability company. In this article, we present an overview of the legal procedure for forming a limited liability company in Israel. We also cover the important things to know before you initiate a process of forming a company.

Limited Liability Company

The formation of a corporation enables an individual, a corporation, a group of people, a group of corporations, or any combination thereof to operate through an entity constituting a separate legal entity. This entity operates separately from its owners and has its own rights, obligations, and actions. The corporation will be subject to the laws and regulations that apply to it, depending upon the type of corporation, and will enable its owners to achieve common goals. There are several types of corporations in Israel— a registered company, a partnership, an NPO, a cooperative society, and a statutory corporation.

When one or more people or corporations want to conduct business activity in Israel, the best alternative available to them is to form a registered company. The Companies Law prescribes two alternatives for forming a registered company. The first is forming a company in which the shareholders’ liability for the company’s debts is limited (a limited liability company). The second is forming a company in which the shareholders’ liability is not limited. The first alternative is the most common and accepted in the business activity in Israel.

Shareholders and Equity

Any person, including a corporation, may form a company. The Israeli Companies Law allows the formation of a company with a single shareholder and demands no initial minimum equity to form it, apart from paying a formation fee.

There are no statutory restrictions on foreign corporations and foreign citizens forming a company in Israel, and they can register as shareholders of an Israeli company. When forming a company, the founders must complete company formation forms and draft the company’s articles of association. The company’s articles of association must include the following details: the name of the company, the company’s objects, the company’s share capital, and details regarding the limit of the shareholders’ liability. All other rules prescribed in the articles of association are optional. The articles of association are tantamount to a contract between the company and its shareholders. Therefore, they are of utmost importance for the management of the company, and supersede (with respect to the company) any other arrangement between the shareholders.

Directors

Any person, including a corporation, may serve as a director in a limited liability company. The minimum number of directors in a limited liability company is one. There is no limit on the maximum number of directors, unless otherwise prescribed in the articles of association. The Companies Law does not prescribe any restriction on foreign corporations and foreign citizens holding office as directors of a company.

Classes of Shares

When forming a company, the company’s registered share capital is determined, including the number of shares and the classes of shares. Shares of the company may have a par value, or all of them may be no-par-value shares. The shareholders’ principal rights are the right to vote, the right to receive a dividend, the right to limited information, and the right to peruse the company’s documents.

Upon forming the company, it is customary to decide that the company’s share capital will consist of only one class of shares (ordinary shares). However, a company may decide on several classes of shares (for example, ordinary shares, preferred stock, or management shares), where the holders of a particular class of shares enjoy additional or different rights in the company. As a rule, a right prescribed in the articles of association regarding a particular class of shares will apply to all holders of that class of shares.

Procedure for Forming a Limited Liability Company

The procedure for forming a limited liability company is relatively simple. The process takes a few days to complete and upon submission of the documents to the Israeli Registrar of Companies, it is possible to receive a certificate of formation of the company within four business days. For the most part, receipt of the certificate happens earlier than this, assuming the submission of all necessary documents to the Registrar of Companies.

To form a company, the founders must complete the following documents in Hebrew only (apart from the articles of association, which they may submit in Hebrew or English):

1. Company formation form, including details such as the company’s name, the shareholders’ personal details, address, the composition of the company’s share capital, and the allotted share capital.
2. First directors’ declaration form.
3. The articles of association, signed by all of the shareholders.

The company must submit the company formation forms to the Registrar of Companies signed by its directors and shareholders, who attest there is no obstacle to their registration as shareholders or directors, as the case may be.

Foreign Citizens as Shareholders and Directors

When signing company formation forms in a foreign country, a notary and apostille must authenticate the signature and the Registrar of Companies must receive the originals for registration.

When all directors and shareholders of a limited liability company are foreign citizens or corporations, the Israel Tax Authority requires the appointment of a local representative for tax purposes. Furthermore, sometimes directors must sign forms and attestations before an Israeli attorney (requiring face-to-face signature verification and not via technological means) in order to perform various actions during the routine management of the company (such as opening a bank account). Therefore, we recommend appointing at least one Israeli director in order to enable the company to operate easily and efficiently.

Actions Subsequent to the Company’s Formation

In order to initiate business activities, after the Registrar of Companies certifies the company’s formation and upon receipt of a certificate of incorporation, it is customary to carry out several additional actions. These include opening a bank account and opening a file with the Israeli tax authorities (VAT and income tax). These actions require the completion of additional documents and various procedural actions, which sometimes require the physical presence of a representative (director) of the company.

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Yuval Lazi leads the M&A practice group in Barnea Jaffe Lande, and Dana Ben-Yehuda is an associate in our firm’s Corporate Department

Barnea Jaffa Lande Law firm is at your service if you have any questions about establishing business activities in Israel or about any other commercial issues.

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