The Legal Director is delighted to be supporting Informed Funding’s latest seminar, Personal Financial Strategies for Business Owners at Workspace's Grand Union Studios. Business finance is typically discussed in terms of finding sufficient funding for the trading entity. However, for the great majority of New and Growing Companies (NGCs), the personal financial outlook for the ownership team is deeply entwined with the company – and it’s often where barriers to success arise.
Could a Shareholder Agreement save your business?
Here at The Legal Director, we’ve recently come across a business where the two co-founders have fallen out – one is now leaving in order to set up on his own, in direct competition with his former business partner. The leaving partner has demanded a significant (and in our view wholly unreasonably) sum to be bought out which the other cannot afford. Whilst these complications are sorted out the business has more or less stopped trading, as its bank account needs both directors as signatories.
In another instance, one of two owner directors of an electronic engineering business has suddenly died. His young widow, who has a background in sports coaching, has inherited his stake in the business and, encouraged by her parents, is proposing to sit on the board and assume a proactive interest in the business.
Of course, neither circumstance had ever been envisaged at the time that the two businesses were set up. But in each case, and to the obvious discomfiture of those involved, an unexpected development looks set to see shareholder value put at risk.
Yet it doesn’t have to be like that. A simple piece of paper could have prevented both situations.
To us, the analogy that best comes to mind is perhaps that of a fire extinguisher. It sits there, doing nothing, perhaps prompting people to wonder why on earth it’s there in the first place.
But in the event of a fire, it promptly comes into its own, putting out the blaze, and making people glad that they had it. In short, when there isn’t a fire, you don’t need a fire extinguisher—but when fire does break out, it’s almost certainly the only tool to hand that will do the job.
So too with shareholder agreements. For the vast majority of the time, they’re not needed, and—like a fire extinguisher—they just sit there, do nothing. And the simple fact is that many businesses—indeed, the vast majority—will never need one.
Yet when fire breaks out, in the form of significant shareholder disagreements or uncertainty, then a shareholder agreement comes into its own.
So what is a shareholder agreement?
At its most basic, you can think of a shareholder agreement as simply a set of rules, governing how the business is to be managed.
Who can make decisions about the business? Which decisions have to be unanimous, or carried out through weighted majority voting? What procedures are to apply in the case of any proposed transfer of shareholdings? Are existing shareholders to be offered the right to buy? How is the price to be calculated? What happens when a shareholder dies, or is incapacitated, or simply wants to retire?
Such questions, at their starkest, are the questions that will most trouble many businesses. But they’re also the very questions that a shareholder agreement can do a lot to assist with, should there be a dispute about the best way to address them.
Simply put, the shareholder agreement sets out the way forward, eliminating uncertainty and doubt, and providing a solid framework for constructive dialogue and action.
Protecting shareholder value
More to the point, perhaps, the shareholder agreement is more than just an understanding or an agreement—it’s an understanding that is enshrined in a legally-binding document.
So should your business have a shareholder agreement? In our view, it’s certainly a sensible precaution, just like that fire extinguisher.
Because no matter how well partners know each other, and how closely they work together at the outset of a business venture, that close cooperation can’t be guaranteed to continue.
And in such a situation, a shareholder agreement provides a set of rules to govern what happens, in a way that isn’t detrimental to the business, and which protects shareholder value.
That said, it’s important that the shareholder agreement is properly constructed in a way that is appropriate for the business in question, and appropriate for the parties involved. Which is why it’s best to be cautious about some of the ‘off the shelf’ templates that are out there.
Typically, we reckon that a properly drafted shareholder agreement involves a couple of days’ work—talking to the various parties, establishing their wishes, and enshrining these in a legally-binding document.
And in our view, it’s a very sensible investment for a business to make.