The decision to go into business with someone is rather like a marriage – we sign contracts and set clear parameters regarding the relationship. We choose our business partners taking into account complementary skills, like-minded goals and a mutual desire to see the business succeed.
Like a marriage, business relationships can grow together or grow apart. Sometimes, due to unforeseen circumstances or a change in aspirations, they can fail. Therefore, it may come as a surprise to learn that many businesses operating in New Zealand today as partnerships or companies are doing so without any formal agreement, leaving them exposed to risk.
Often, the people who you begin your business with may not continue to have similar intentions for the company. A difference in life stages between business owners might mean that there comes a time when you want to take greater risks and expand the business overseas, while family commitments and financial security are more important to your business partner.
A couple of years into a business it is not uncommon for a founding shareholder to decide that they want to exit the business. This can be traumatic for everyone involved as they may take valuable skills and knowledge with them. There is then the awkward issue of share valuation – friendships can be ruined in the process.
In these situations, clients frequently turn to the law to provide them with answers, but without a Shareholders’ Agreement in place they are living dangerously. A remedy or resolution of differences is not always straightforward.
We have had a number of files where good friends, family members or acquaintances have gone into business and subsequently spent large sums of money on legal fees when they decide to go their own way and end their business relationship.
One such heart-wrenching case we dealt with saw two professionals who ran a successful business together for three decades, battling to resolve their differences when one business partner had a change in life focus and no longer wanted to continue in business together. Unable to agree on a buyout figure, they spent many acrimonious weeks and tens of thousands of dollars on legal fees because they didn’t have a Shareholders’ Agreement in place providing them with a clear cut way to exit.
So, how do you avoid the emotional and financial costs of a business gone bad and what do you need to know when it comes to Shareholders’ Agreements?
Put simply, a Shareholders’ Agreement is a contract between shareholders of the company. It is a must for any SMB that has more than one owner. Not unlike a ‘prenup’, Shareholders’ Agreements provide shareholders with certainty as to the nature of their relationship with each other, and assist in progressing the development of the company and protection of each shareholder’s initial investment. It provides a pre-agreed format for exiting the company and ensures there are no surprises should this situation arise.
Getting a business off the ground involves many costs. Once you are open and operating, it is then easy to get caught up in the day-to-day demands of building a product or service, leaving little time for anything else. Spending money on a Shareholders’ Agreement often takes a back seat to more immediate priorities, but planning for the ‘what if?’ scenarios should not be overlooked.
Raising these matters from the outset will start the relationship off on a positive, stable and secure footing. We recommend building the cost of the Agreement into your start-up budget. It is an investment that could potentially save you thousands.
Among other things, a Shareholders’ Agreement records the shareholders’ intentions as to:
• How the company will be run.
• Entry and exit of shareholders.
• What happens if one shareholder dies or is unable to work.
• Resolution of disputes that may arise between shareholders.
Important provisions generally found in Shareholders’ Agreements include:
• Relationship of the shareholders – Shareholders agree to act in the best interests of the company in priority to any other business in which they are involved.
• Directors – Shareholder rights to appoint and remove directors are agreed. It is useful to set out how directors are to be paid and how meetings are to be co-ordinated. It is also important to clarify the employment relationship for those shareholders who may be working in the business.
• Major decisions requiring special authorisation – Shareholders agree on those matters which are so important that they require unanimous agreement of shareholders and those matters requiring a special resolution of 75 percent of the shareholders. This would be particularly useful if one of the business partners has a mid-life crisis and decides he or she needs a gold-plated desk and a Porsche.
• Company management – Provisions for the preparation and compliance with annual business plans and budgets, monthly management accounts, projected revenue and expenditure budgets and financial reporting.
• Shares – Shareholders agree at the outset the method to value the shares in the company and the procedure by which shares may be sold. These often include pre-emptive rights where existing shareholders have the first right of purchase.
• Standstill date – The period during which the shareholding of start-up companies may not change in order to allow the company to become established.
• Restraint of trade – Shareholders agree to a reasonable restraint period and restraint area within which they may not be involved with any other business in competition with the company.
• Termination – These provisions set out the situations where certain actions by a shareholder will be viewed as a default, requiring the shareholder to exit the company. This is particularly useful if your business partner decides to take the business Visa card to the casino.
• Dispute resolution – Shareholders agree the dispute resolution procedure that will be used if a dispute arises between them, such as mediation or shareholder buy-out.
A strong footing
Discussions about Shareholders’ Agreements can be sensitive, requiring you to think about some fundamental issues such as the initial business plan, responsibilities and future growth. A commercial legal team that has experience in these matters will help guide you through the process and advise on appropriate provisions for your particular situation.
Clarifying these issues early on in the business will help get the company off on a strong footing. The Agreement may sit in your files for years to come but should an unforeseen event arise, you have planned for it, and you will have a clear framework to work out a resolution. The best time to take out life insurance is when you are young and healthy. The same applies to you and your business when it comes to Shareholders’ Agreements.