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Start Up Thinking: when should your client consider a shareholders agreement?

Despite the optimism and enthusiasm of most startup businesses, directors’ circumstances can change – and often outwith their control. Shareholders agreements can be a useful framework in stressful situations.

You are approached by two clients who want to go into business. You explain the tax, accounting and trading implications of the usual structures. They select a company structure. They are to take a 50/50 share in the business and they are both to be directors. They each subscribe for one share in the capital of the company and they are each appointed as a director. The Model Articles are adopted. The company is deadlocked from the start and they just have to agree everything. That is fine: they are optimistic about the future and their working relationship.

But… what happens if one of them dies? Or is incapacitated? Or just wants out? Or they want to bring someone else in to the business?

If one shareholder dies, her share in the business forms part of her estate. So the share will go to those named in her will, or her next of kin. We have seen a sad situation where one party found that his business partner was now his deceased business partner’s two year old son. A similar situation may arise if a business partner is incapacitated. If she is incapable of running his affairs, her family may step in. And, if she wants out, this might just end up being a horse trade, and a bitter one.

This is because the Model Articles simply don’t tell us what to do in these circumstances. The Model Articles are largely permissive, and are predicated on the parties agreeing. But in difficult times, agreements can be hard to make, increasing stress, paralysing business and eroding value.

A solution is for the parties to enter into a shareholders’ agreement at the outset. It will not eliminate the stress of a difficult situation, but it will provide a framework for decision making and agreement. A simple shareholders’ agreement might set out:

  1. additional rules for the management of the company: typically, key strategic decisions would need a special majority or unanimity. The parties can also agree an approach to board meetings, reporting, business planning etc;
  2. a method for one party to buy out the other if the other party dies, or is incapacitated and, importantly, set out a method for valuing the shares in those circumstances;
  3. basic standards of performance and adherence to the business, so that the parties can hold each other to account. This can be backed up, if necessary, by bad leaver provisions;
  4. basic agreements on funding the business and dividend policy; and
  5. a strategy for bringing the business to an end if it is not working out.

A shareholders’ agreement should go in a drawer while the parties concentrate on building their business. But the confidence that a shareholders’ agreement gives clients should not be underestimated. Challenging issues can be aired during an optimistic time, rather than in a crisis. And the business owners can go forward knowing what is expected of them and that, if things don’t work out as planned, they have a plan.

If you would like further information on the topic discussed in this article, please contact Andrew Fleetwood by email: afleetwood@gilsongray.co.uk or by phone: 0131 516 5365 / 07841 920 101. You can also view Andrew’s profile by clicking here.

The information and opinions contained in this blog are for information only. They are not intended to constitute advice and should not be relied upon or considered as a replacement for advice. Before acting on any of the information contained in this blog, please seek specific advice from Gilson Gray.

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