It comes up quite often, a business is started or bought between family or friends or colleagues, and a company set up to own and run the business.

What you then have is a partnership of people who are now in business together.  Most often these people have not worked together before, and may not in fact know each other particularly well, but they are now in a business relationship.

As we all know, relationships are dynamic, can change over time, be influenced by altered circumstances and changes in priorities.

So where is this discussion heading? It is the need to invest upfront in a well thought out and practical shareholder (or partnership) agreement that puts a framework around key areas and issues for the operation of the business, duties of each person involved, rules around exiting the business, procedures for resolving disputes, rules on what happens on the death of a person or a marriage split up and so on.

Do most people do this? Some do but a lot don’t and the reason a lot don’t is mainly due to wanting to keep set up costs down, so the less legal costs the better, and because at the start of a new project everyone is positive and enthused so it is difficult to make the leap to view how life might be if it has all gone wrong.

Ok, so let’s look at the ” it’s all gone wrong” scenario.

A business owned by 3 people has run successfully for a number of years, through a company, but the market has changed, trading is reduced and there is a need to inject more capital to clear a bank line.

Two shareholders are ok with this, but the 3rd does not have the resource.  The 3rd refuses to put in more money, and the bank is insisting on repayment.

So what we have is a disagreement between shareholders brewing and the business under threat of receivership if the bank line is not repaid.  Each shareholder is also a guarantor.

For this business, the shareholders have no shareholder agreement that would set out the rules on how to deal with an issue like this.  The 2 shareholders who want to inject money cannot force the 3rd shareholder to put money in, nor can they make a decision to recapitalize the company without the 3rd shareholder agreeing.

So if they want to save the business and protect their personal position under the guarantee they have no option but to pay out the bank themselves. The 3rd shareholder then ultimately receives the benefit of this without having put up their pro-rata share of funds.  Worse, the other shareholders resent this and the relationship breaks down.  The business is heading for disaster.

Incidentally, the 2 shareholders went off to their lawyer for advice on their options when this first arose and then went through a negotiation with the 3rd shareholder who also went of to his lawyer, which then escalated to a dispute etc.  The combined legal cost of this could easily be 10 times the cost to put in place a shareholder agreement at the beginning.

So, AlexanderDorrington recommends spending a bit more upfront and put in place a suitable shareholder or partnership agreement, at the beginning. We have considerable experience in this area and are happy to provide a cost estimate after an initial no-cost meeting to understand your proposed business project.

By Craig Alexander