Shareholder Disagreements and Business “Prenups”
It is usually exciting when people come together to work and invest in a joint business venture. The parties are often so positive, mutually trusting and confident that they will be successful working together that they pay little or no attention to documenting the arrangement properly.
All too often reality sets in; and down the track they disagree about something and one or all parties decide they want to part ways. Costly and acrimonious shareholder disputes can result, and the lack of cooperation can erode the value or even the viability of the business that the parties have developed together. All parties could end up losing their investments in the venture (both in cash and “in kind”, including time and effort).
A Good Shareholders Agreement – The Best Solution
A good way to retain the value of the business and minimise the costs and acrimony involved when shareholders part company, is to ensure that a well thought out Shareholders Agreement is in place beforehand. Amongst other things, the agreement should deal with situations where there is disagreement between the parties.
Many co-venturers operate on the basis that all decisions must be unanimous. They often say that if they cannot all reach agreement then the venture is already over, and they may as well all pack up and go home. To us this seems unrealistic. In any relationship numerous areas of disagreement are bound to occur, and the important thing is to work out whether or not the issue is critical, i.e. a “deal breaker”. If it is not a deal breaker, then the parties need to find a way to continue to work together despite the disagreement.
Although it may not be a good idea for all decisions to require unanimous consent, it is advisable to require key decisions to be made by unanimous consent (such as whether to sell the business or a material part of it, change the business, merge admit a new shareholder).
Well-structured Voting Rights
(Similar to political democracies), if the issue is not a deal breaker, a good approach is for the parties to agree to disagree, put the matter to the vote and graciously accept the outcome. To assist in reaching a decision by way of vote, the relative shareholdings and voting rights need to be looked at and the issue of a “casting” or “deliberative” vote considered. (Sometimes the chairperson is given a “casting” or “deliberative” vote to break a deadlock).
Exit if Deal Breaker
If an issue arises which is a deal breaker, then the agreement should facilitate a smooth separation. Some parties prefer that the business be sold and the net proceeds split between the shareholders pro rata (according to respective shareholdings). Others prefer that one or more shareholders buy some or all of the others out, in which case the thorny issue of valuation (i.e. how much should be paid) should be dealt with in the agreement. Again, if a clear valuation mechanism is set out in the agreement, then there does not have to be a dispute about it: The mechanism is triggered and processed, the parties accept the outcome and everyone moves on.
A valuation mechanism could include the appointment of a valuer. Another approach would be to set out the formula for calculating the value and nominating the company’s accountant (or other expert) to perform the calculation and advise the parties of the result. It is theoretically possible (but rarely practical) to specify an agreed dollar amount in the agreement as the business’s value (subject to periodic reviews by agreement or vote).
An interesting approach adopted by some is to use “Shotgun clauses”, also known as “Russian Roulette clauses”. For further details about this, see our article on Breaking the Deadlock, “Shotgun Clauses” and Free Exits here.
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If you would like to discuss any aspect of this article with us, or share your own experiences, please contact Rod Stumbles at +613 8692 7255 or here.
This article provides general information only and is not intended to constitute legal advice. No lawyer-client, solicitor-client or attorney-client relationship has been created between us. You must not rely on the contents of this article, whether as an alternative to legal advice from a lawyer or other professional legal services provider or otherwise. You should not take, discontinue or refrain from taking any action because your understanding of the contents of this article, including without limitation delay seeking legal advice or disregard legal advice. If you have any specific questions about any matter, you should engage us or other lawyers or other professional legal services providers to provide you with the necessary advice. Keep in mind that you may be facing important deadlines so you should not delay in engaging someone to provide you with the advice.