Shareholders agreements: Defence in the face of dispute

A common story…

Good friends Alex and Joanne have come up with a brilliant new business venture. They’ve tested it and invested in planning and launch. It’s full of potential, and they’re all guns blazing. They get along well and are both enthusiastic and positive about their ability to make it happen together.

Alex and Joanne work hard from day 1 and execute their business idea. So much so, their business explodes in its first couple of years. But then things go pear-shaped…

One day Alex and Joanne have a huge falling out. It seems sudden but it’s been brewing. After Alex organises a private investor meeting for the third time and spends more time focusing on reducing cost and improving short-term revenue, Joanne loses her cool and tells Alex she wants him to sell his share to her. Alex has always seen himself as a short-term business owner that turns great ideas into quick profit by selling off. Joanne never intends to sell. She loves the business and doesn’t want anyone else coming in. She is committed to her employees and is upset that Alex has removed two junior employees to save money. Alex has no intention of selling to Joanne and feels he has put more in and has the say over what to do with the business.

The split is irreparable. Alex and Joanne never got advice and nothing is documented. There is no shareholders agreement to provide guidance or direction on how to deal with what is now a stalled business, with owners at loggerheads.

It’s not unusual that as a business grows, individual expectations, ambitions and commitments diverge. Things can get messy quickly. Like in the case of Alex and Joanne this can result in irreconcilable differences, disputes and deadlocks.

What could help them right now?

Alex and Joanne needed to think about what it would mean to formalise their business relationship from the outset with a well-structured shareholders’ agreement.

Why would a shareholders agreement help?

The purpose of a shareholders agreement is to manage the relationship between the parties so that the company can run smoothly and profitably with minimal conflict or confusion. In essence, they set the rules of engagement for entering, managing and exiting the business venture.

When should you look into getting one?

Shareholders agreements, like prenuptial agreements (yep, it’s a good comparison!), should be prepared from the outset, when hopes are high, everyone’s on their best behaviour and nothing’s gone wrong (yet).

However, shareholders agreements don’t just act as an insurance policy in the event that things turn out badly. You may agree to sell the business in due course, a shareholder may wish to exit voluntarily, or you may choose to bring in a new investor. These are all scenarios that can benefit from having an upfront written agreement.

What happens in the event of a dispute?

As mentioned above, shareholders agreements should set out the ramifications for breaches, and outline the process for dealing with disputes like those faced by Alex and Joanne.   

Disagreements can be very difficult to resolve and where two shareholders own 50% each, there is no such thing as a majority decision. Having a strategy to deal with stalemates in these circumstances becomes critical.

You need to decide, from the outset, what you will do if, like Alex, you want to bring in a new investor or sell the business, but your business partner doesn’t. Failure to do so is a recipe for disaster.

There are a number of approaches you can take to resolve a deadlock. These include:

  • Mediation: each shareholder agrees to mediate to resolve their disagreement;
  • Deterrence: fixing a price where one shareholder buys out the other’s shares e.g. 125% of the market value;
  • Russian roulette: one shareholder buys out the other shareholder’s shares or sells their own;
  • Texas shoot-out: each shareholder puts in a sealed bid to buy out the other’s shares. Whoever places the higher bid must buy the other’s shares;
  • Shotgun arrangement: one shareholder specifies a price at which they’ll buy the other out, or be bought out at that price, and the other decides whether to sell or buy at the nominated price; and
  • Sale at a pre-agreed valuation: e.g. multiple of earnings.  

Serious deadlocks may destroy value and trigger the winding up of your business venture, so having well-defined criteria for the resolution of disputes in your shareholders agreement is a great circuit breaker and potential lifeline.  

Reach out

Yes, disagreements and conflict are inevitable in any business relationship – even ones underpinned by friendship. The best thing you can do is create security for yourself by reaching a concrete understanding of business operations from the get-go. While a structured shareholders agreement can’t eliminate all problems that arise in business, it can make the relationship smoother and less problematic.

If you’re interested in learning more, or need assistance in drafting a shareholders agreement, feel free to reach out to Martin at E: martin@corvus.com.au or call him on M: 0459 849 629.