Calculating Sunk Reliance Costs Against Unissued Equity In Unregistered Partnerships
Sunk reliance costs measure direct out-of-pocket expenses and lost wages incurred when operating under an unfulfilled equity promise in an informal partnership.
pre-incorporation terms
Meaning
Contractual arrangements agreed upon by founders before the formal registration of a corporation. Pre-incorporation terms outline the intended distribution of equity, the specific roles of each participant, the schedule for asset transfers and the strategy for initial funding. They act as a memorandum of understanding that governs the relationship during the pre-legal phase of the business.
Once the entity is formed, these terms are usually superseded by a formal shareholders agreement.
Promoter Liability
Individuals signing documents before the entity exists often bear personal responsibility for those contracts. Even if the pre-incorporation terms state that the company will take over the lease, the founder is the person a landlord seeks payment from if the company is never formed. This personal exposure lasts until the new board of directors formally adopts the agreement through a process of novation.
Failure to transfer these obligations leaves the founder’s personal assets at risk.
Equity Expectation
The promise of a certain percentage of the future company is the primary focus for most early participants. Because pre-incorporation terms are often written before a professional valuation, they might specify fixed percentages that become problematic when investors arrive. A founder who promises twenty percent of the company to a developer might find that this commitment conflicts with the requirements of a seed round.
Balancing these early promises against the needs of the growing firm is a common source of tension.
Conflict Resolution
Disputes over early agreements are settled based on the intent of the parties at the time of drafting. If the pre-incorporation terms lack a clause for mediation, the parties may end up in a legal battle over the ownership of the initial code. The record of early meetings and drafts provides the context for what was actually agreed.