Shareholder Agreements:  The Corporate “Pre-nup”

Maybe you’ve dreamt it up with a friend.  Maybe you need to bring someone in with the expertise or contacts or capital to get it off the ground.  While there are plenty of good reasons to go into business with other people, let’s be honest – relationships are tricky. 

That’s why even people in love often document their relationship by way of a “pre-nup” in case of heartbreak down the track. This kind of “hope for the best but plan for the worst” mentality is well-advised and equally applicable to your business relationships, which will no doubt start off enthusiastically.  However, the combination of work, stress, time, effort, money and life in general can be lethal to both your working relationships and your business.  A shareholders’ agreement is essentially a corporate “pre-nup”.  It can help to clarify the framework and structure of your business from the start and to foresee, manage and guide you through pressure points as and when they eventuate.

The process of negotiating a shareholders’ agreement should be constructive in terms of how exactly the business will be operated and can reduce the risk of a dispute arising in the first place.  Start how you mean to continue by clearly setting out the parameters of your business relationship in writing. 

Some of the key matters to discuss and agree include:

• What is the ownership split?
• How will the business be funded initially? What about further capital requirements?
• Who is contributing what (i.e. money, skills, labour, equipment)?
• What are your respective roles in the business? Will you both work in the business or is one of you more of an investor?
• What is the level and frequency of remuneration for shareholders working in the business (cash flow/profit permitting)?
• Who makes decisions and who is in control? Are there limits to that decision-making power (i.e. what requires unanimous agreement and what can be done without the consent of your co-founder)?
• What are your obligations as a shareholder? What happens if someone materially or persistently breaches those obligations?
• Will shareholders be required to personally guarantee the lease, bank loans or credit arrangements on behalf of the company? This can be difficult where co-founders have an imbalance of personal assets.
• How can new people join the business and how can existing people get out? Having an agreed exit mechanism is essential.
• What are the restraint arrangements both during and after involvement with the business?
• What is the dividend policy (i.e. is a certain level of dividend payment intended or is this subject to board discretion)?
• Are there pre-emptive rights? If they are not exercised, are there any restrictions on who can you sell your shares to (i.e. competitors)?
• What happens if either of you dies or becomes incapacitated? Aside from the grief, you probably don’t want to suddenly be in business with your co-founder’s husband.
• To fund the purchase of your co-founder’s shares in the event of death or incapacity, insurance arrangements could be considered.
• What happens in the event of a disagreement? There must be a dispute resolution procedure to ensure there is a way to resolve it and move forward one way or another.

These are just some of the matters to consider – a shareholders’ agreement should be tailored to suit the nature of the business and the aspirations and expectations of the founders from the outset. Not only will this help to avoid future issues, it supports sound business practices and can also make investment in or acquisition of the business more attractive to third parties in the future.

All things going well, you may never have to look at the fine print again.  But even best laid plans can go awry.  If they do, the business relationship can rapidly sour and place the business at risk of failure as the focus shifts to the dispute.  While it is not a silver bullet, your shareholders’ agreement is the first port of call and gives you a map to navigate stormy seas.  Without one though, it can be virtually impossible for people to agree a way forward and the business can languish or die in the meantime.

If you are considering going into business with someone else or would like to document an existing business relationship, please get in touch with our Business Advice Team or your usual contact at Hesketh Henry.  We would be happy to discuss the implications in further detail and assist you with getting an appropriate shareholders’ agreement in place.

Disclaimer:  The information contained in this article is current at the date of publishing and is of a general nature.  It should be used as a guide only and not as a substitute for obtaining legal advice.  Specific legal advice should be sought where required.