Pre-Nuptials have been making the news again in recent times causing lurid reading for the more voyeuristic amongst us (and some sleepless nights for those without this protection who are planning or fearing a divorce). I’ll leave it to you good readers to make your own minds up on which sides to take on this 21st Century issue. However, if you are planning to start a business or have a business with one or more shareholders or partners there is a vital piece of advice you should heed; make sure you have a clear and comprehensive shareholder or partnership agreement in place – one day you willneed it! Yes, it can be a pain doing it, it costs lawyers’ fees and you spend valuable time drafting an agreement to cover eventualities you are convinced that you’re never going to meet.
However, I have seen many situations where things went wrong and the lack of a properly drafted shareholder agreement made matters far worse. So, while it’s common in some circles to talk in less than flattering terms about lawyers (perhaps less now bankers have earned their place in the publics’ mind) but, trust me, engage a good one to help draft your shareholder agreement because one day you are going to rely on it.
Shortly after I joined the board of one company as non-executive director, it became apparent that the two major shareholders were falling out due to the non-performance of one of them. I arrived one morning to find that one shareholder had fired the other an hour or so before. Reading the shareholder agreement (over a much needed cup of coffee) I found that there was no provision requiring a departing shareholder to sell his equity. Now, at the time, the business was a long way from a possible exit but the thought of coordinating a future sale with a long-fired, absent shareholder who had no obligation to sell was too horrendous to contemplate. After a long and extremely delicate negotiation, I managed to achieve a buy-back of his shares.
A senior executive of a VC I worked with lamented with me over a situation where they had a long-standing minor equity stake in a family business. Now here they had a shareholder agreement but one that could fit on the back of an envelope. My colleague had the right to attend board meetings but had to suffer the strictures of an imperious chairman who instructed him to ‘sit quietly, laddy and don’t interrupt’! There was no way the family shareholders would agree to either sell the company or to buy the VC out. The family shareholders simply enjoyed healthy dividends as a result of the separate class of share they held and all my colleague could do was sit and fume at board meetings with an equity stake that was generating no return.
Consider the following scenario; three shareholders have long had an unwritten understanding that they would take healthy dividends and modest salaries (being more tax efficient). Times get a little tough and two directors decide to make the third redundant. The third, upset as he is at being ousted from the company he helped created, is consoled with a verbal assurance from the remaining two that, although no longer a director or employee, he will retain his equity and will continue to participate in dividends. The two remaining shareholder directors instead cease paying dividends and hike their salaries leaving the redundant third without any income.
Another problem that can bite an unwary business owner in the rear quarters is the lack of a ‘tag along’ clause. This refreshingly named clause does exactly what says and provides for a shareholder to be able to sell his equity for exactly the same price as that which other shareholders have negotiated with a prospective purchaser. Without this ‘one out, all out’ protection a major shareholder (or majority shareholders) could negotiate the sale of their equity leaving behind a shareholder who otherwise would have wanted to leave. Looking ahead, and unless he could negotiate a new shareholder agreement with his new partners (and why would they), he could find himself in the same situation all over again at some future point.
Of equal importance is the value of a ‘drag along’ clause. Imagine a situation where three shareholders (with equal equity) have started a company that has done particularly well and is earning good profits. As their success grows, a competitor makes an extremely attractive offer for all of the equity. Negotiations proceed smoothly but just before completion, one shareholder decides that he doesn’t wish to sell out from the company he helped create (he is the youngest and, apart from his attachment to the business, and decides that he can earn more from the business if they reject the offer and expand the business instead). Without any requirement in the shareholders’ agreement to require him to sell his equity, the sale falls through, resentment grows between the three shareholders and the business then suffers.
Going into business with a partner or partners is exciting (and rightly so). You’re in love with your business plan and what you are going to create together. You are great friends perhaps and all trust each other implicitly. But in just the same way as we humans fall in and out of love with the opposite sex, business partners have their equivalent behaviour. Forget your shareholder (or partnership) agreement or get this one wrong and it can break your wealth (and your sanity).
So, before you get into similar problems, get together with your business partners, engage the services of a good lawyer and let them help you put together a shareholders’ agreement that can plot a course through these and many other situations you never want to imagine. It could be the best money you ever spend.
Have you had an unhappy business partnership or do you know anyone who has?