Why Founders Should Put Directors’ Service Agreements in Place from the Outset

Why Founders Should Put Directors’ Service Agreements in Place from the Outset  

When starting a new company, founders often spend significant time and effort negotiating and finalising a shareholders’ agreement, believing that once this document is signed, the legal groundwork is complete. However, it’s remarkably common for founders to overlook the equally important need for directors’ service agreements – the contracts that govern how each founder-director actually works in the business.

While the shareholders’ agreement regulates how the company is owned and how decisions are made at shareholder level, the directors’ service agreements (DSAs) deal with the day-to-day working relationship between each founder and the company itself. They set out what each director is expected to do, the time they will commit, and how they will be remunerated. Without these documents, even the most carefully drafted shareholders’ agreement can quickly unravel when the practical realities of running the business bring tensions to the surface.

The purpose of a Directors’ Service Agreement

A DSA is a legally binding contract between a director and the company which sets out the director’s employment terms, duties and responsibilities. Unlike a standard employment contract, it reflects the dual role of a director as both an employee and an officeholder of the company.

For founders, the DSA is crucial because it formalises expectations around how much time and effort each director is required to devote to the business, what they will be paid, and what happens if their circumstances change – for example, if they wish to reduce their involvement, pursue other ventures, or if a falling out occurs between founders.

Without this clarity, resentment and mistrust can easily build when one founder feels they are carrying more of the workload, or when disagreements arise over what each person is entitled to receive.

Key matters covered in a Directors’ Service Agreement

While every business will have its own nuances, there are several core areas that every founders’ DSA should address clearly and consistently:

1. Roles, responsibilities and working commitment
   The agreement should describe each director’s remit, for example, who will lead on sales, operations, finance, or technology – and the level of time commitment expected. This avoids misunderstandings later when one founder assumes another will work full-time or take on certain tasks. For early-stage companies, it’s also wise to include provisions for reviewing and adjusting responsibilities as the business evolves.
2. Remuneration structure
   Founders often agree to a modest, tax-efficient salary (up to the National Insurance threshold) with the balance of income taken as dividends. The DSA should record this approach clearly, along with the mechanism for any salary reviews or bonuses. While dividends are typically dealt with in the shareholders’ agreement and company constitution, it’s helpful for the DSA to confirm that directors’ total remuneration will follow the agreed policy, ensuring fairness and transparency.
3. Confidentiality, intellectual property and restrictive covenants
   Founders are often the key innovators. The DSA should ensure that all intellectual property developed in the course of their work automatically belongs to the company, not to them personally. Confidentiality obligations and post-termination restrictions (for example, against competing businesses or soliciting clients or staff) are essential to protect the company’s value.
4. Termination and notice periods
   The DSA should set out how the relationship can end, whether through resignation, removal as a director, or termination for cause. This section should dovetail with the “good leaver” and “bad leaver” provisions in the shareholders’ agreement to ensure consistent outcomes if a director leaves. For example, a “bad leaver” dismissed for gross misconduct should forfeit or be required to sell back their shares, whereas a “good leaver” who departs amicably might be entitled to retain them or sell at fair value.
5. Decision-making and authority
   Founders’ DSAs can define individual authority limits, such as spending thresholds or entering contracts on behalf of the company. This helps to maintain control and accountability as the business grows, particularly where not all directors are involved in daily operations.
6. Dispute resolution and mediation
   It can be helpful to include a clause requiring directors to attempt mediation or other informal resolution methods before resorting to legal action. Founders are often friends or long-term colleagues, and early dialogue can prevent disputes from escalating unnecessarily.

How the DSA, Shareholders’ Agreement and Articles should dovetail

While the DSA governs the personal working relationship between each founder-director and the company, the Shareholders’ Agreement governs their rights and obligations as owners. This includes provisions on:

• Dividend policy: how profits are distributed, which often links directly to the directors’ remuneration structure in the DSAs.
• Good and bad leaver clauses: determining how a departing shareholder’s shares are treated, ideally cross-referenced with termination clauses in the DSAs.
• Buy-back and valuation mechanisms: detailing how and when the company or remaining shareholders can acquire the shares of a departing director.

In turn, bespoke Articles of Association may set out different share classes, for example, non-voting shares for passive investors, or separate classes for founders to vary dividend or control rights. These constitutional documents should all be drafted to complement one another, ensuring there are no contradictions between employment and ownership arrangements.

Common issues when DSAs are overlooked

When founders fail to implement directors’ service agreements, several problems frequently arise:

• Unclear expectations: Without agreed roles or working commitments, tensions emerge when one founder feels another is not “pulling their weight.”
• Remuneration disputes: Ambiguity around pay and dividends often leads to disagreements, especially if the company begins to generate profits.
• Unprotected intellectual property: Without a clear assignment clause, IP created by a founder might legally belong to them personally rather than the company.
• Difficult exits: If a founder leaves, the absence of dovetailing provisions between the DSA and shareholders’ agreement can make it difficult to enforce a buy-back of their shares or prevent damaging competition.

Final thoughts

Putting in place comprehensive and consistent Directors’ Service Agreements at the outset of a new venture is not merely an administrative formality – it’s a fundamental part of protecting the business, its founders, and future investors.

These agreements, when aligned with the shareholders’ agreement and the company’s Articles, create a coherent legal and commercial framework that supports trust, transparency and accountability. In short, they allow the founders to focus their energy on building the business – not on managing internal conflict later down the line.

The Jonathan Lea Network regularly advises founders, family businesses and co-owned ventures on how to structure ownership, draft shareholders’ agreements, and manage the balance between personal and professional relationships. If you’re planning to start a business with friends or relatives, our experienced team can help ensure your company is set up for long-term success, with both your business and your relationships protected.

Please email wewillhelp@jonathanlea.net providing us with any relevant information ensuring that any call we have is as productive as possible or call us on 01444 708640. After this call, we can then email you a scope of work, fee estimate (or fixed fee quote if possible), and confirmation of any other points or information mentioned on the call.

 

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This article is intended for general information only, applies to the law at the time of publication, is not specific to the facts of your case and is not intended to be a replacement for legal advice. It is recommended that specific professional advice is sought before relying on any of the information given. © Jonathan Lea Limited.

 

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