Disclaimer: This article is general information only. It is not legal advice, does not create an advocate-client relationship, and is not an advertisement or solicitation.
Two friends settle on a business idea over tea, then hurry to reserve a name and file for a private limited company. Eight months later one of them wants to step back, and nobody has written down what happens to his shares. This is among the most avoidable disputes in young companies, and it starts before incorporation.
Contents
Why the agreement comes before the filing
The Companies Act, 2013 gives a private company a skeleton. It needs at least two directors, one of whom must be resident in India for 182 days in the year (Section 149). It restricts the transfer of its shares and limits its members to 200 (Section 2(68)). The Act does not say who works full time, who contributes the brand or the code, or what happens if one founder stops contributing. Those are commercial questions, and the founders' agreement is where they get answered.
What a founders' agreement should cover
| Topic | Question to answer | Why it matters |
|---|---|---|
| Roles and time | Who works full time and who part time? | Equity expectations usually follow effort. |
| Equity and vesting | Are shares earned over time, with an initial cliff? | A founder who leaves in month four should not hold a full stake. |
| Intellectual property | Does everything created for the venture belong to the company? | Names, logos and code created before filing sit with individuals until assigned in writing. |
| Reserved decisions | Which decisions need every founder's consent? | New shares, borrowing and a sale of the business should not turn on a bare majority. |
| Exit and transfer | Is there a right of first refusal, a buy-back on departure and a method to fix the price? | Keeps shares out of unwanted hands. |
| Disputes | Escalation, mediation, then arbitration with a named seat? | A deadlock plan costs less than a deadlock. |
Agreement and Articles: who is bound
A founders' agreement is a contract among the founders. The company is not bound by it unless the company signs too. In V.B. Rangaraj v. V.B. Gopalakrishnan (1992), the Supreme Court held that a restriction on the transfer of shares that does not form part of the Articles is not binding on the company or its shareholders as a matter of company law. The practical lesson is to put the terms that must bind the company, such as transfer restrictions, into the Articles of Association.
Section 5 of the Companies Act, 2013 also allows entrenchment provisions in the Articles, meaning specified clauses can be changed only under conditions stricter than a special resolution, with notice to the Registrar. Writing the key terms into the Articles at the start is simpler than amending them later.
Where it fits in the incorporation sequence
The integrated SPICe+ form (INC-32) carries the Memorandum (INC-33) and Articles (INC-34). After incorporation, Section 10A requires a declaration of commencement of business in Form INC-20A within 180 days. For related reading, see our notes on name reservations and filing traps and on share transfers in India.
Common mistakes
The first is an even split with no tie-break mechanism, which turns every disagreement into a stalemate. The second is no vesting, so a departing founder keeps everything. The third is leaving brand and software in personal names. The fourth is copying a template without adjusting it to the actual roles and funding plans. Also be careful with clauses that stop a founder from working elsewhere after exit. Section 27 of the Indian Contract Act, 1872 treats agreements in restraint of trade as void, so broad post-exit restrictions may not be enforceable, while confidentiality and narrow non-solicitation terms are on firmer ground. Founders weighing a different structure may also read about converting a partnership firm into an LLP.
Frequently asked questions
Is a founders' agreement legally binding in India?
It can be, as an ordinary contract under the Indian Contract Act, 1872, between the people who sign it. The company is not bound unless it is also a party, which is why terms that must bind the company are better placed in the Articles as well.
Should founders sign before or after incorporation?
Before is common, because roles, equity and ownership of work already done are being decided then. After incorporation, the company can be added as a party, or a shareholders' agreement can follow once investors or new shareholders arrive.
Does an LLP need something similar?
An LLP is governed by its LLP agreement under the Limited Liability Partnership Act, 2008, which is filed with the Registrar in Form 3 within 30 days of incorporation. The same questions on roles, exit and disputes should be answered in that document.
Questions on a specific matter depend on the facts, and advice should be taken before acting.