We all start off with the best of intentions. We have a great idea, we discuss it at length, and work out a way to monetise it. We agree that everything should be 50/50, set up a website, and off we go, happily into the sunset.
Everything goes well until it doesn’t. So how can we best protect our business and ourselves if something does go wrong?
Trent Le Breton, principal at McCabes Lawyers advises that the best way to avoid stressful, and potentially costly problems for start-up businesses is to put in place a solid shareholders’ agreement. “A standard form company constitution will rarely cover all of the issues that a new business is likely to face,” he says. “Often it fails to accommodate the special intentions of the shareholders in respect of managing the venture. A shareholders' agreement however, can help define expectations up front, including payment and exit plans should a shareholder want to leave. A shareholders’ agreement leaves little room for misunderstandings between the parties about what will happen if things don't develop as expected.”
Le Breton goes on to say that shareholders’ agreements typically set out the rights and responsibilities of each shareholder. For instance, particular investors may require board appointment rights, irrespective of the shareholding.
The agreements can also stipulate that ‘drag-along’ or ‘tag-along’ mechanisms apply in regards to the sale of shares, and set out particular situations in which a shareholder can be forced to sell their shares (for instance, death, insolvency, termination of employment).
The split of shares can be anything, as long as they add up to 100%. For example the founder may wish to hold 60% and issue their partner 40%, it all depends upon what each party brings to the table.
Another advantage of having a shareholders’ agreement is that it adds to the marketability of the business, should you wish to bring in additional investors and capital to grow the business.
“Acquirers rarely want to buy 90% of a company. The Corporations Act 2001 (Cth) addresses this issue in respect of listed public companies, and unlisted public companies with 50+ shareholders, by permitting compulsory acquisition of 100% of the shares in an entity once a shareholder reaches the 90% ownership threshold,” says Le Breton. “A shareholders' agreement can simulate this in the private company context, making the business more marketable because the majority can deliver all the shares on issue to potential buyers on exit. This incidentally gives those prospective acquirers comfort, because they know the majority can deliver the target without the risk of significant due diligence and deal costs being wasted in the face of an immovable minority.”
Here are Le Breton’s top 5 tips to consider when starting a new business:
- Reflect on the key goals for your venture. Are you starting up to sell the business, or do you plan to run it for income-generating purposes for the long term?
- Talk to your co-owners about what their intentions and expectations are for the venture.
- Evaluate the management strategy you intend to adopt. Is it fair? Are all parties responsible equally? Do rewards reflect this?
- Clearly describe the roles and contributions of each owner.
- Negotiate a shareholders' agreement early.
These are the details that frequently get overlooked when starting up a company. Often we are too focused on the product and the clients. Although they may not seem important in the beginning, these issues become increasingly important as the business grows and increases in value. This is the reason why a shareholders’ agreement is vital. It is an invaluable tool for you and your co-owners to articulate how you plan to run and exit your business.
As you make plans for your new business, make sure a detailed shareholders' agreement is in the mix of your top priorities. It is a relatively inexpensive process that can end up saving you down the track.