So you have just decided to use a company to operate your business or venture with another person or persons. The Company’s Constitution is the usual standard form and sets out everything you need. Right? No wrong!
Standard form company Constitutions are very basic and do not cover anything more than the bare essentials. You definitely need a Shareholder Agreement as well.
A Shareholder Agreement is a document which governs the legal and business relationships between all the shareholders and the directors.
Shareholder Agreements commonly set out:
How shares are sold/transferred and the valuation basis;
The different rights and responsibilities of shareholders and directors;
How the company and its business will be run;
The parameters of any decisions that need to be made;
Restrictions upon the sale of shares; and
A dispute resolution process to resolve any deadlocks.
Why is a Shareholder Agreement needed?
A Shareholder Agreement sets out and protects your future business relationship. It provides clarity as to approach when the parties disagree or want to exit the business.
Is it expensive?
As each business relationship is different, there is no ‘standard’ document. However, the costs of agreeing and signing a Shareholder Agreement is significantly less than the costs that will be incurred if there is a dispute because the shareholders and directors were not clear on how things were going to be managed or resolved.
Your fellow shareholders are long-standing friends, therefore a Shareholder Agreement is not needed.
Whilst you may have known your business partners for several years, people’s circumstances and priorities change over time. A Shareholder Agreement sets out a way in which common circumstances are handled. If agreed at the outset, a Shareholder Agreement is agreed at a time when people are enthusiastic and normally approach matters on a fair and equal basis. Our observation at Millens is that Shareholder Agreements agreed after a business has been running for a while (if they can then be agreed at all) tend to take a longer time to agree (and are therefore more expensive) as the parties will then have their own entrenched interests to protect.
Common examples surrounding shareholder/partnership disputes.
Millens has advised many shareholders and directors who do not have a Shareholder Agreement in place. Below are some examples of the issues that directors/shareholders have faced.
Three long-standing friends set up a business and no Shareholder Agreement was set up as they ‘trusted’ each other to do the right thing. After several years of profitability, the business lost its major customer and this had a significant impact upon the profitability (and viability) of the business.
The directors/shareholders attempted to raise extra bank funding to keep the business running whilst new replacement customers were developed. One director had not filed tax returns for several years so the funding was declined. That director was asked to resign in order that funding could be obtained or alternatively contribute capital on the same basis as the other directors. The director took issue with this, walked out and refused to make any additional contributions. The now ex-director issued proceedings claiming that the company was being mismanaged and he was being oppressed.
The matter eventually settled, however, the combined legal spend of all parties was more than $250K and the internal costs of responding to the ex-director and the legal proceedings were more than $150K. These costs could have been avoided or at least substantially minimised had a Shareholder Agreement been signed at the outset.
Four individuals agreed to go into business together. One individual came up with the business “idea”, whilst the three others agreed to put in the capital. After a couple of years, the “idea” shareholder / director wanted to sell his shares and start a business on his own using the “idea“. A dispute occurred over the value of the shares as well as the use of the “idea”. The 3 other shareholders / directors claimed that the “idea” shareholder / director was not entitled to a market valuation of the business nor was he entitled to use the “idea” elsewhere.
Like the example above, a significant amount of money was incurred by the parties as no agreement as to how to value the shares on exit could be agreed nor as to how the “idea” could be used. Had these matters been agreed at the outset the exit of the shareholder would have been relatively painless. It would have also been clear as to how the “idea” could be used.
Two individuals merged their own businesses to form a bigger business. Each was responsible for maintaining their current customers as well as growing the business. A Shareholder Agreement was drafted but was never signed as the directors / shareholders were busy and the agreement was forgotten. The business became very successful but was reliant upon the individual director relationships with their customers.
Unfortunately, one of the directors suffered a personal tragedy and wanted to exit the business and focus on caring for his family. A dispute arose between the directors as to the timing of any exit as well as the value of the exiting director’s share of the business. Both directors disagreed as to the valuation basis as well as the timing of any exit. Not only were substantial costs incurred by both parties in agreeing a valuation basis, the exiting director had to manage the business matters whilst handling the personal crisis. Had the Shareholder Agreement been agreed then the exit process would have been clearly established and set down.
Next steps – Millens
So if you are setting up a business (or have a business) which will be operated as a company you must protect your future business interests by having a Shareholder Agreement agreed and signed right at the outset.
This also applies to any other similar business structures such as a Partnership Agreement for a partnership or a Joint Venture Agreement for a joint venture. In every case your business structure needs a carefully drafted fundamental Agreement between all the business participants.
Millens is your innovative solution for your professional business needs. We are nimble and responsive. We offer an enthusiastic, commercially experienced group of legal professionals who have proven track records in providing not just legal but other related business services and advice.
We will provide you with:
clear commercial solutions
accurate and pragmatic advice
an understanding of your business
personal attention at all times
Contact us today to discuss how we can assist you with a Shareholder Agreement or other commercial business matters.