Avoiding Disputes With Your Business Partner

By John Sier, Principal, MST Lawyers

All too often in our business, we come across cases of shareholder conflict.  It is particularly the case where two friends or associates build a business together as equal shareholders in a company. In the early days, everyone gets along, and there appears to be no need for concern.  The parties often build up a significant business without considering how “trigger events” such as death, incapacity, divorce or disputes may impact their business.

The legal costs associated with resolving issues in the absence of a shareholders’ agreement are extremely expensive.

Benefits of shareholders’ agreement:

Clarify Decision Making

A shareholders’ agreement can clarify which decisions require both parties’ approval.  Typically they may include employment of staff members, obtaining finance or selling the business. Structuring control around decision making helps reduce disputation, and the shareholders/directors have some clarity around their rights and obligations.

Option To Buy/Sell

If a trigger event were to occur, the agreement could provide for a resolution to that issue.  It can provide a process for one party to buy out the other or for one party to force the other to buy them out.  Often that buyout option is subject to a formula and in the instance of one shareholder being forced to buy another out there may well be a terms payment arrangement built into the shareholders’ agreement.  In the case of death or disability, the option is often supported by insurance.

Drag Along/Tag Along

In some instances, one shareholder may be offered a considerable sum for his or her shares.  There are normally pre-emptive rights in the constitution of the company to provide that the remaining shareholder has the first right of refusal in respect of that transaction.  A shareholder’s agreement can go one step further and provide for the ability to drag along the other shareholder to the transaction in circumstances where the purchaser may wish to acquire the entire company.  Alternatively, the other shareholder may have the ability to “tag along” to that transaction so that he or she is not left with a new shareholder/director who may be an unacceptable partner to the remaining shareholder.  The rights to tag along are particularly relevant in the case of a minority shareholder seeking protection.

Valuation Formula

A shareholders’ agreement often provides a formula for valuation of the relevant equity which is the subject of a “trigger event”. This formula provides clarity and transparency around the valuation in a buyout. The company accountant should review the formula annually so that it remains relevant.

Case Study

One case in particular, where the wife retained her husband’s equity in a company after his passing, highlights the importance of a shareholders’ agreement. The other shareholder/director became the sole director and then resolved to double his salary and defer making dividend payments from the company to the shareholders; notwithstanding that there was $3m in the company bank account.  The wife of the deceased was left in a difficult situation whereby the substantial income from her late husband’s business was stopped, and her previous high standard of living was compromised.  A simple arrangement of buy-sell provisions secured by life insurance in a shareholders’ agreement would have allowed the wife to exit with minimal fuss and the remaining shareholder to assume control of the business with minimal expense.

Conclusion

We all prepare a Will for our personal affairs. It is also critical to consider how we deal with our business assets.  We can spend decades building equity in our business only to lose it all if trigger events are not considered in advance.  The value of that equity must be protected for the benefit of your family.

For more information or an initial no obligation meeting, please contact John Sier by email or call +61 3 8540 0270.