Why not get a shareholders agreement with your business partner?

Starting a business is an exciting time. When going in to business with other people it is important to establish a formal agreement setting out the ground rules of the relationship for this new venture. This is in case initial expectations do not work out as you had planned. 

Even if your business is a company or a partnership you and your partners need to formalise this new working relationship. The document will be either a partnership agreement, a shareholders’ agreement or, if operating a trading trust, a unitholders’ agreement.

Although not mandatory, it would be wise to have an agreement stipulating such things as:

• the agreed responsibilities of each participant in the operation of the business
• what contribution each participant is bringing into the business — skills, know-how, access to funding and connections
• profit and loss sharing formulae
• consequences of failure to deliver one’s responsibilities
• future funding options
• exit mechanisms
• decision making process, including day-to-day business operations and internal matters, such as the remuneration of directors (where there is a company structure), reinvestment of dividends/profits into the business
• short and long term business plans, and
• procedures when one participant becomes incapacitated or dies.

What can happen without an agreement

Partnerships start smoothly with everyone striving to fulfil the shared vision. Over time, however, this common goal may change slightly for individual partners. Eventually diverging to the extent of becoming separate goals. Disagreements boil up about how the company is being managed or regarding future plans. Conflict disturbs the daily running of the business, often creating an unpleasant work environment for all employees.

Making money is difficult enough without needing to spend time and emotional energy handling disputes between partners.

What can go wrong?

Below are some examples of problems that business owners encounter:

• a major participant whose asset to the business is his/her skills in the trade/profession decides to set up shop in competition but refuses to relinquish his/her shares in the original business
• a shareholder/partner refuses to hand over money for the business and its expansion is curtailed
• time-sensitive decisions cannot be made because a director will not attend board meetings
• directors refuse to disclose company books to shareholders
• a potentially profitable sale of the business is lost because minority shareholders hold out against it
• when a party seeks to sell out, disputes arise regarding the valuation of shares/interests in the business
• a partner/director wants to spend more time with family and cash in on his/her efforts, but there is no ready market for a portion of an interest in the firm and pressure is placed on the other partner(s)/shareholders to sell the whole business
• for his/her own benefit, a director misuses information and this is detrimental to the company
• the question arises as to what is a “fair” split of income/profits after one partner/director takes up the role of major “fee earner” and the others focus more on business development
• one partner/shareholder is offered a premium for the firm, but the other partners/shareholders hold out with some refusing to consider a sale.

What happens then?

A partnership, shareholders’ or unitholders’ agreement provides a mechanism for dispute resolution. Without this agreement, applying for a court order may become necessary.

Some of the reasons court orders can be sought include:

1)      the dissolution of a partnership

2)      the winding up of a company

3)      injunctions to prevent a party from dealing with the assets of the business

4)      directions as to the conduct of the company’s affairs, or

5)      one shareholder to purchase the other’s shares/interests at a price to be determined by the court.

Frequently parties cannot agree on how to proceed and a resulting court order seems to favour only one of the parties involved; ensuing in a hostile parting of ways.

Obviously, besides the anxiety and the unwanted time and expense of court proceedings, your business is in an unstable state while handling disputes with a business partner.

Invariably those who suffer the most are the remaining shareholders/partners/unitholders who want to continue with the business.

The best course of action prior to forming a partnership is to establish the ground rules with your potential business partner or partners.

Next steps

Take the time to thoughtfully discuss at least these thirteen items with your potential business partners:

1)      the vision, mission and values of the business (sounds cliché, but really these underpin all business decisions to be made)

2)      the initial set up costs, ongoing financial requirements

3)      marketing plans to create your niche in the market, put your services in front of your target audience to elicit engagement and response

4)      possible strategic alliances with other professionals

5)      whether employees will be recruited and, if so, pro forma terms need to be considered

6)      the partners’ respective roles in the business, perhaps setting initial KPIs

7)      remuneration of the partners

8)      contingency plans when one or more partners become incapacitated

9)      create “liquidity” by setting out exit procedures

10)   have tag-along and drag-along clauses so that the business/company can be sold upon the occurrence of a triggering event

11)   business succession planning

12)   restraints that will apply upon termination of the relationship, and

13)   how the business will be valued upon termination (a valuer or a firm can be nominated in the agreement).

At the conclusion of formulating the professional relationship the documented agreement must be signed by all parties.

No partner wants to contemplate the possibility of their partnership turning sour or a partner losing focus of the shared goal of doing what is best for the business. Up front at the beginning of a partnership, establishing an agreement, may in the long term save partners a substantial amount of time, stress, and money.

Disclaimer:

Hillyer Riches Management Pty Ltd , accountants and advisors located in Caulfield, is a Corporate Authorised Representative (No 466483) of Capstone Financial Planning Pty Ltd. ABN 24 093 733 969. AFSL / ACL No. 223135.This document contains general advice only and is not personal financial or investment advice. Also, changes in legislation may occur frequently. We recommend that our formal advice be obtained before acting on the basis of this information.