What is a Letter of Undertaking (LUT): Meaning, Process, Format

Understanding the Importance of a Co-Founder Agreement

A co-founders agreement is a governance framework. It provides clarity on expectations, defines legal boundaries, and establishes protocols for decision-making and dispute resolution.

Without it, startups risk misalignment, equity disputes, or founder exits that can derail momentum. Having this agreement from day one ensures:

• Legal protection for all founders
• Clear accountability
• Faster resolution in case of conflicts
• Long-term business stability

How to Determine Roles?

Before you split the equity or assign job titles, align on why you’re building this company. Once your mission is clear, it becomes easier to define what roles each founder should play.

Not all founders are the same, and not all will lead the same functions. Role clarity prevents overlap, power struggles, and decision-making delays.

Here’s a quick overview of typical leadership roles:

• CEO (Chief Executive Officer): Sets vision, makes high-level decisions, and manages investors.
• COO (Chief Operating Officer): Manages day-to-day operations, hiring, and internal workflows.
• CFO (Chief Financial Officer): Oversees finances, fundraising, and budgeting.
• President: Often works alongside the CEO, focusing on strategy execution or external relations.
• CMO (Chief Marketing Officer): Leads branding, marketing, and growth strategy.
• CTO (Chief Technology Officer): Drives product development and tech architecture.

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How to Split Equity?

One of the trickiest parts of a co-founder agreement is deciding who gets what percentage of the company.

Spoiler alert: Equal splits are often unfair. While it might feel diplomatic to go 50/50 (or 33/33/33), it rarely reflects the actual contributions of each founder. Equity should reward value creation, not just presence.

Consider these factors:

• Who initiated the idea?
• Level of early involvement and contribution
• Full-time vs part-time commitment
• CEO or leadership responsibilities
• Prior experience, networks, and domain expertise

It’s advisable to use structured frameworks or equity calculators and ensure all discussions are documented. Vesting schedules (typically four years with a one-year cliff) should also be agreed upon and reflected in the agreement.

Compensation and Salary Expectations

Most early-stage startups operate with limited capital. Founders often defer salaries or draw nominal compensation. However, clarity on current and future remuneration is essential.

The agreement should include:

• Initial salary (if any) or deferred compensation model
• Milestones or triggers for compensation reviews (e.g., seed funding, profitability)
• Equity-to-cash trade-offs, especially for operational founders
• Provisions for salary revisions approved by a board or mutual consent

Decision-Making and Dispute Resolution

Defining decision rights helps prevent operational gridlock and ensures strategic alignment. The co-founders agreement should outline the following:

• Voting rights: Specify which decisions require a majority, supermajority, or unanimous consent (e.g., capital raise, hiring key executives, M&A decisions).
  
• Dispute resolution mechanisms: Include mediation and arbitration clauses to resolve disagreements outside of court.
  
• Deadlock provisions: Outline how to handle situations where founders are split, potentially via third-party adjudicators or rotating authority.
  
• Exit protocols: Determine how decisions are made in case a founder decides to leave or is asked to step down.

Exit Strategies and Buyout Clauses

Exit events, whether planned or unforeseen, can significantly impact the startup’s equity structure. A co-founders agreement should detail:

• Voluntary exit protocols: Including share sale rights, notice periods, and replacement planning.
• Involuntary exit terms: For cause (e.g., misconduct) or no-fault exits (e.g., health issues).
• Buyout clauses: How shares are valued (e.g., pre-agreed formula, external valuation), who has the first right to buy, and what triggers a forced sale.
• Non-compete clauses: Restrictions on joining or starting competing ventures post-exit.

Without a clear exit plan, founder departures can become messy, expensive, and emotionally draining.

Non-Disclosure Agreements (NDAs)

Startups thrive on ideas, data, and speed. A loose-lipped founder or ex-founder can derail all of that. To protect your IP, customers, and strategy, include a strong non-disclosure clause in the co-founder agreement. It should cover:

• What qualifies as “confidential information”?
• How long the NDA lasts (often 1–3 years post-exit)
• Consequences of breaching the NDA

Founders should also agree on how sensitive materials like business plans, prototypes, and user data are handled upon exit.

Death, Disability, and Divorce Clauses

Contingency planning for life events is often overlooked but is essential to safeguard the business. Your agreement should include:

• Death clause: Specifies who inherits equity, buyback options for the company, and whether heirs receive any operational role.
  
• Disability clause: Details how long a founder can be inactive before reevaluation and whether shares can be repurchased or roles reassigned.
  
• Divorce clause: Ensures founder shares don’t get transferred to a spouse, with provisions for company buyback to retain control.

These clauses protect both the business and surviving founders from unforeseen legal and financial disruptions.

Frequently Asked Questions

What Is Capital Redemption Reserve?

The Capital Redemption Reserve (CRR) is a special reserve that a company must create when it redeems (buys back) its preference shares using its profits. As per corporate law, companies must transfer an amount equal to the nominal value of redeemed preference shares to the CRR to prevent capital reduction and maintain financial integrity.

When Is Capital Redemption Reserve Used?

CRR is utilised in various financial scenarios to maintain corporate stability, including:

• Issuing bonus shares: CRR can be used to issue fully paid bonus shares to shareholders.
  
• Funding share redemption: Ensures funds are available for preference share redemption.
  
• Capital reconstruction: Helps restructure a company’s capital without impacting free reserves.
  
• Balancing capital losses: Used in cases where capital losses need adjustment.
  
• Source for share buybacks: Required when companies buy back shares using free reserves.
  

Redemption Of Preference Capital

The redemption of preference shares is subject to the following regulations:

• Must be permitted in the Articles of Association.
  
• Redeemable within 20 years of issue.
  
• Methods of redemption:
  
  • Using Distributable Profits: Requires CRR creation.
    
  • Issuing Fresh Shares: CRR creation is not required if new capital is issued.
    
• Shareholder Approval (75%): Required for further preference share issues.
  
• Premium Payment: This can be funded from company profits or the securities premium account.
  

Modes of Redemption

The three primary modes of redemption are:

1. Using Distributable Profits: CRR creation is mandatory, equal to the nominal value of redeemed shares.
   
2. Issuing Fresh Capital: If a company issues fresh capital equal to the redemption amount, CRR creation is not required.
   
3. Combination of Both: CRR is required only for the portion funded through distributable profits.
   

Modes of Redemption of Preference Shares

Companies can redeem (buy back) preference shares using one of the following methods:

1. Using Distributable Profits
   The company uses its retained earnings or other profits to redeem the shares. In this case, it must create a Capital Redemption Reserve (CRR) equal to the nominal value of the redeemed shares to maintain financial stability.
   
2. Issuing Fresh Capital
   The company raises funds by issuing new shares to replace the redeemed preference shares. Since this method does not reduce capital, creating a CRR is not required.
   
3. Combination of Both
   A company may use both profits and fresh capital for redemption. CRR is required only for the portion funded through distributable profits, while the part covered by fresh capital does not require CRR.

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Calculation and Accounting Entries For Capital Redemption Reserve

Calculation of CRR

CRR = Nominal Value of Redeemed Preference Shares (if using distributable profits)

Journal Entries

Application of Capital Redemption Reserve

• CRR can only be used for issuing fully paid bonus shares.
  
• CRR cannot be used for dividend distribution.
  
• CRR must exclude unrealised gains and self-generated intangible assets before determining free reserves.
  
• Classified as a statutory reserve, separate from revenue reserves.
  

Companies Act and Capital Redemption Reserve

• Section 55: Companies redeeming preference shares from profits must transfer an equivalent amount to CRR.
  
• Section 69: Companies buying back shares using free reserves or securities premiums must transfer an amount equal to the face value of bought-back shares to CRR.
  

Difference Between Capital Redemption Reserve and Other Reserves

Tax Benefits For Capital Redemption Reserve

Under Section 36(1)(viii) of the Income Tax Act, 1961, specified entities can claim a tax deduction on contributions to a Special Reserve, reducing their taxable income. The deduction is capped at 20% of profits from eligible business activities before applying this clause. However, any future withdrawal from the reserve is treated as taxable income in the year of withdrawal.

Importance Of Capital Redemption Reserve

• Maintains Financial Stability: Prevents a reduction in share capital.
  
• Protects Shareholders’ Interests: Ensures capital is available for redemption.
  
• Supports Capital Restructuring: Used in financial restructuring strategies.
  
• Ensures Legal Compliance: Meets regulatory requirements under the Companies Act.
  
• Enhances Investor Confidence: Used for issuing bonus shares, benefiting shareholders.
  

Final Thoughts

The Capital Redemption Reserve (CRR) plays a vital role in corporate finance by ensuring companies retain sufficient funds while redeeming preference shares. As a statutory reserve, it helps maintain financial stability, protects creditors' interests, and complies with legal requirements.

While it cannot be used freely like other reserves, its role in issuing fully paid bonus shares makes it a strategic asset for companies looking to optimise their financial position.

Frequently Asked Questions

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Encourages aspiring entrepreneurs to kickstart their business ventures.

Gyaan Shakti

Offers knowledge and ecosystem support to women entrepreneurs, nurturing entrepreneurship.

Karma Shakti

Provides practical assistance to entrepreneurs in establishing and expanding their businesses.

It specifically provides access to programs for

• Incubation and acceleration
• Entrepreneurship skilling and mentorship
• Marketing assistance
• Funding and financial assistance
• Compliance and tax assistance
• Community and networking

Eligibility

Any woman entrepreneur with an established or new startup or just a business idea can benefit from this scheme.

Application procedure for Startups

• Visit https://wep.gov.in/.
• Click on the “Register” button on the homepage. Following this, a registration form will appear on the screen.
• Fill in all the details and click on the “Register” button at the bottom of the page.
• After completing registration, a page will appear asking for “Areas of Interest” and relevant fields.
• Fill in all the Personal Information, Business Information, and Educational information. Keep in mind that the fields might vary depending on the area of interest you are choosing.
• Successful submission of details leads you to become a member of the WEP and grants you access to several benefits.

Benefits of the WEP

WEP actively hosts a wide range of events as a platform, providing resources and promoting entrepreneurial communities.

• It provides monetary assistance, including seed capital, growth capital, line of credit( LOC), and non-credit support.
• Promotion of offline initiatives and outreach programs by partnering with other organizations.
• Incubation and acceleration support to startups founded or co-founded by women entrepreneurs registered with the program.
• Identification of skill gaps and providing online/offline training on these aspects.
• Marketing and networking support to early-stage or established entities
• Compliance services to registered users, which provides them with the essential tools to adhere to legal compliances, perform registrations, furnish accounts, make loan applications, provide license counseling, and so on.
• A like-minded community to understand the true spirit of entrepreneurship and the way forward.

To provide better support, WEP has tied up with some Fortune companies like CRISIL, Facebook, SIDBI, NASSCOM, DICE, FICCI, Mann Foundations, Shopclues, CII, and many others. The fortunes will play a key role in developing different skill sets important for a robust entrepreneurial ecosystem.

Frequently Asked Questions