Setting up a new company is exciting but with so much to do in building revenues it can be easy to lose sight of the importance of formalising arrangements, especially for those who have little prior business experience.
To make life easier it is usual to agree in advance how the company will operate, who will be responsible for what, the degree of power people can wield, how disputes should be resolved and what happens if someone wants to leave.
Many of these matters will be dealt with in the company’s articles of association, but some will need to be covered off in a separate shareholders’ agreement.
The problem is that while having articles of association is compulsory, creating a shareholders’ agreement is not and this can lead to the need for such an agreement being overlooked and, as a recent case handled by David Grabiner in our corporate and commercial team demonstrates, this can result in significant difficulties arising.
The case in question involved a company which had been set up by two friends, both of whom had knowledge of the industry they were planning to operate in but neither of which had run a business before, albeit one of them professed to have financial experience.
While having articles of association is compulsory, creating a shareholders’ agreement is not and this can lead to the need for such an agreement being overlooked.
Things went well initially but took a turn for the worse when the trust and confidence that needs to exist between business partners began to ebb away.
David became involved when one of the co-owners came to him for legal advice on his options for exiting the company in the absence of a shareholders’ agreement having been prepared.
The situation was complicated, as David explains:
‘Our client shared ownership of the company with a friend. The deal was that they would both be directors holding a 50 per cent shareholding. The work would be split between them but with our client’s co-director managing the finances.’
‘Not long after the venture had been established our client became concerned that money was going missing and that his co-director might be to blame. A confrontation took place in which our client’s suspicions were aired and the allegations were denied. However, our client’s concerns remained.’
‘Relations deteriorated and our client suggested that the business be sold so that he and his partner could secure a return on their investment and go their separate ways.’
With no shareholders’ agreement in place providing a roadmap for this scenario, we had to think practically about how an orderly exit could be achieved.
‘This suggestion was initially accepted, but once a buyer had been found and a sale agreed his co-owner had an apparent change of heart and began to stall until the sale eventually fell through.’
‘At this point, our client considered cutting his losses and walking away but, having invested a considerable amount of time and money in the venture, he was reluctant to do so. He therefore resolved to take legal advice and it was at this point that we became involved.’
‘With no shareholders’ agreement in place providing a roadmap for this scenario, we had to think practically about how an orderly exit could be achieved.’
‘Given the client’s need to see a return on his investment the obvious answer was to ask his co-owner to buy him out, but as money was tight it seemed unlikely his partner would be able to raise the funds needed to achieve this – at least not in a lump sum.’
‘As a result, we considered the possibility of a deferred consideration arrangement whereby the money would be paid in instalments. However, this carried the risk that should the business subsequently go under, our client could be left out of pocket.’
‘We contemplated handing the matter over to our litigation team to pursue our client’s allegations of wrongdoing against his co-owner. However, in view of the lack of documentary evidence and the inherent litigation risk, we advised the client to try to reach an amicable resolution which avoided the need for court action.’
It was a deal that everyone was happy with and which enabled our client to extricate himself from the company on the best possible terms.
‘We suggested a hybrid approach, whereby the client would sell their shares in return for part of the money up front and the balance later, on condition that his co-owner agreed to pick up liability for all debts and provide an indemnity to back this up.’
‘It was a deal that everyone was happy with and which enabled our client to extricate himself from the company on the best possible terms, safe in the knowledge that if the company subsequently went to the wall he could pursue his former partner for any monies still owed through a simple debt action.’
‘This was a great outcome, particularly when you consider that the alternative would have been to issue costly proceedings which may or may not have been successful.’
If you need advice on extricating yourself from a company, why not give David a call on 020 7845 7462 or email at davidgrabiner@iwg.co.uk to see how he can help.
David can also advise on the unravelling of partnerships and joint ventures and on corporate matters more generally. Additionally he deals with a broad range of commercial contracts, including bespoke shareholders agreements.
This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published.