Tip 1 – Get it done at the Beginning
The single biggest mistake we see is that the participants fail to prepare a shareholders agreement at the outset of the venture. There can be many reasons for this, including but not limited to the following:
- it may not occur to the parties that they need a shareholder’s agreement at all;
- one or more of the participants is avoiding ‘difficult conversations’ about control, management and expectations; and
- the legal costs may be seen as prohibitive.
The problem here is that by the time the need for a shareholder’s agreement is realised, such as in a dispute, it is often too late to reach an agreement. Trying to get consensus after the risk has materialised can be very challenging.
By contrast, it is far easier to get reasonable consensus in advance – before the dispute arises.
Tip 2 – Understand your business partners may not always be who you think
This is not just about relationships deteriorating, although that does definitely happen and is reason in itself to have a shareholder agreement.
The fact is you may not even end up dealing with the same individual. Absent any agreed restrictions or procedures, a shareholder may sell their stake to an unvetted third party. If a shareholder dies, you may end up dealing with their spouse or executors. If a shareholder becomes insolvent, you may be dealing with the bankruptcy trustee.
The shareholders agreement can provide some protection against unexpected third party interference.
Tip 3 – Verify the expectations of each party
Have clear expectations about what each participant will contribute to the business, and how those contribution will be repaid (if at all).
If a participant is contributing cash, consider whether this is a loan to be repaid (and on what terms) or if this is initial share capital.
If one party is contributing their labour to manage the business operations, consider whether they should be employed or otherwise renumerated for their time and how.
However, this is not just about the setup phase, but also the long-term requirements of the business. For example, if one participant will be a supplier to the business, consider whether there should be a supply or service contract in place from the outset.
Consider whether disproportionate contributions warrant differing ownership interests or control.
Tip 4 – Have a clear protocol for deadlocks
50/50 owned and controlled companies can be lethal to a business. If there is a complete breakdown of trust between the parties, there may be no way to manage the company. Directors resolutions cannot be passed, documents cannot be signed, and a majority shareholder does not exist.
Although rarer, deadlocks can still occur with three or more participants in circumstances where there are insufficient directors, or company ownership proportions allow for it. A detailed process should be implemented for alleviating deadlock in ‘at risk’ company structures.
When there is a complete impasse to decision making (particularly in 50/50 arrangements) the only option may be to apply to a court for an order that the company be liquidated. The liquidation of the company will often devalue the goodwill and sale price of the business.
Tip 5 – Have an Exit Plan
It is unlikely all shareholders will want to exit the business at the same time. There are often many personal factors involved in exiting the business. If you decide to exit, consider how your interest will be valued, and who will buy your shares. If another shareholder decides to exit, consider whether you have a pre-emptive right to buy those share, and what price and payment terms are feasible.
In what circumstances can a party be forced to sell their shares? This will depend on the type of conduct that would warrant this course of action and if it is even practical.
Daniel Dash and Zahra Rashedi are part of the commercial law team at NB Lawyers – lawyers for employers working with individuals and business owners on a range of matters including business sales, property disputes, estate disputes, shareholder agreements, intellectual property, litigation and taxation matters.