08 Aug The good, the bad and the ugly truth about shareholders’ agreements
Andrew Dongworth, partner and company and commercial solicitor at HRJ Foreman Laws shares the good, the bad and the ugly side of business partnerships. If your business has shareholders, an up-to-date shareholders’ agreement is essential to protect both the business and the shareholders’ interests.
A shareholders’ agreement will ensure you can mitigate potential conflicts and protect your company’s future.
The good. Protecting the future vision of the business.
Business arrangements can and do evolve. A shareholder’s agreement will help to protect your business from unforeseen changes, such as disagreements over business strategy, partner disputes, or a shareholder wanting to leave the company.
Imagine a company with two co-founders, A&B. A decides to sell their 50% stake in the company and finds a buyer that can proceed quickly. However, the other co-founder – B, is extremely concerned that the new investor does not have the right experience or understanding of the industry to help run the business effectively.
The good news is the company has a shareholders’ agreement which includes a “Right of First Refusal” clause. This means that B gets the opportunity to buy A’s shares before they are offered to an outside party. Negotiations between A & B result in B buying A’s shares using a pre-determined valuation method that was outlined in the agreement. This resolves B’s concerns and avoids a potential dispute.
The bad. The risks of not seeking legal advice for your shareholders’ agreement.
Not all shareholders’ agreements are the same. The details included will depend exclusively on your business, your industry, and your shareholder dynamics. It is important to seek legal advice for a tailored agreement for your business.
Don’t be like the company who created a DIY shareholder agreement.
Sadly, and unexpectedly one of the shareholders passed away. Their agreement did not consider this scenario. As a result the shares went to a spouse who benefitted from the company dividends, but had no interest in the business, nor added any value. This resulted in a laborious process to buy the shares from the spouse, while the neglected employees felt frustrated and unhappy.
All of this could have been avoided if the agreement had stipulated what happens in the event of a shareholder’s death, such as offering the shares to the remaining shareholders at a fair market value.
The ugly. Consequences of not having a shareholders’ agreement.
The absence of a shareholders’ agreement can trigger a domino effect of negative consequences.
For example, two friends, C & D shared the same dream of starting a business. They were successful and things were going well. However, as the years passed and the business grew, they began to disagree over the company’s future. C firmly believed they should expand nationally, while D wanted to maintain the local, boutique nature of their brand.
Without a shareholders’ agreement outlining any dispute resolution procedures, their disagreements escalated. C then wanted to sell his shares, cut his ties with D and pursue his own ambitions. But D could not raise the funds to buy C’s shares.
As the legal fees mounted, the former friends were deadlocked. The only option left was to sell their company to a competitor. A heartbreaking outcome for them both.
This ugly, expensive, time consuming and stressful ending could have been avoided with a well-defined shareholders’ agreement. It would have provided an exit strategy for C, allowing him to recoup his investment while ensuring D retained control.
It’s not too late.
The best time to establish a shareholders’ agreement is during the initial setup phase. However, it’s not too late, if you are already operating. Unexpected events happen, so don’t wait for a crisis before seeking legal advice.
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