New court ruling could see start-up founders prepare business 'prenups'

A recent court ruling on a dispute between two start-up founders could lead to entrepreneurs drawing up founders' contracts that focus more on anti-competition mechanisms and exploiting business opportunities when drafting business contract, Firon Law firm commercial law department attorneys Avi Moreh and Meitar Meiry Dagim told The Jerusalem Post.

Moreh said that it was typical of the Israeli start-up scene for friends to pursue a business together, but may only use simple agreements when they found the company. Another key characteristic of the ecosystem is that Israeli entrepreneurs found multiple start-ups at a time.

An August 6 lawsuit, Tzur v. Empirical Hire et al, saw the familiar formula of the Israeli Start-Up Nation go wrong. According to a ruling by the Tel Aviv District Court, in 2016 two friends, one studying engineering at the Technion-Israel Institute of Technology and the other business at Reichman University, sought to develop an artificial intelligence employee recruitment system.

No founders agreement was signed, and limited company bylaws were developed. In 2017, one of the founders, the defendant in the case, sought to sell off his shares to the plaintiff and separate from the company – but after a back and forth, no agreements were signed. At the same time, the company, Harvest, was turned down for a Reichman University accelerator program investment. Harvest became inactive but was still a registered company. 

The defendant went on to join in the establishment of another company, Empirical Hire, which was in the same field as the first. The plaintiff asserted that the defendant violated his fiduciary duties as a shareholder by operating a competing company. The business ventures could have been realized within Harvest, and the plaintiff demanded a separation package. The Tel Aviv District Court ruled in favor of the plaintiff, awarding them NIS 75,000.

The start-up prenup?

Much of Israeli commercial law on business structures can be found in the 1999 Companies Law, but certain aspects such as separations mechanisms or company’s or officers’ reputation are derived from court rulings, said Moreh. He said that the ruling signaled an emerging norm on the signing of a founders' agreement that would emphasize separation and termination of the start-up.

Meiry Dagim likened the matter to a marriage prenuptial agreement, which outlines how assets will be managed if the couple divorces at a later date. Divorces can be financially messy and emotional, but if one has an agreement ahead of time, then it saves turmoil at a later date. Start-up founders might need to take the same approach to avoid protracted legal battles.

"If you had an agreement on separation, then there wouldn't be a problem now," said Meiry Dagim. This is all the more important because unlike with marriages, partners in Israeli start-ups aren't monogamous. "In the world of start-ups, because ideas aren't certain, people are involved in many projects."

Moreh said that because many of them are students or young, they may not start the business relationship right because they only think about starting.

When asked if the emerging norm could impede the establishment of start-up with more legal hurdles, Moreh said that on the contrary, a clear founder's agreement with a separation plan would make a business more enticing to investors.