From Valentine to Corporate Legal Quandries

by Elemental CoSec on February 15, 2012

With Valentine’s Day having just passed us by and people still caught up in the joy of partnership it is perhaps worth casting an eye over the some of the issues around jumping into bed with a partner when it comes to your business. Specifically, some of the corporate legal issues when two or more people set up a company together.

There are, of course, plenty of advantages of having a business partner. They give you a broader set of skills, knowledge and contacts as well as someone to boost you up when things are struggling and keep your feet on the ground when things are going well. However, there are plenty of issues that need to be considered as well when you are sharing the ownership of a business.

Set out below are some of the more common issues when two (or more) founders set up a company together. It should be noted that for ease, we have focused on owner managers for this article. There are plenty of other ways that multiple shareholders can come together, notably with an investor or as part of a management incentive scheme. Some of the issues around these scenarios are similar but they do differ in key ways.

The key to dealing with all of these issues is to be upfront with each other from the start and then make sure you are agreed as to how to deal with them. However, any agreement is worthless if it isn’t properly documented and the best way to document your agreement is in the company’s articles of association or shareholders’ agreement. These are complicated documents, so please get in touch with the experts at Elemental CoSec to discuss their corporate legal services and company secretarial services.

What happens if one person leaves?

If a founding shareholder decides to leave and pursue other opportunities it can leave the remaining shareholder(s) in a tricky situation. They can either buy out the leaving shareholder (assuming such a deal is possible) at a time when they want to invest all their money and time in the business or the leaving shareholder gets to benefit from the later growth of the business without contributing any of the work.

Neither situation is likely to be agreeable to all parties. Therefore you need to consider in advance whether any ‘leaver’ provisions should be included in the articles setting out what happens to someone’s share if they cease working for the business.

As part of this decision, it is also worth considering whether the leaving shareholder should be permitted to go and work for a competing business or set them up in competition.

What happens if the shareholders disagree on the direction of the business?

At the outset everybody will hopefully be in agreement on the best way to progress the business but as time goes on, these views can start to diverge. As a basic principle, the majority will normally prevail (whether that’s the majority of directors of the owner of the majority of shares) but you may not always want this to be the case.

Shareholders (especially minority shareholders) need to think very carefully about how decisions are going to be made and what happens if they disagree with the fundamental direction of the business in a few years’ time. Minority shareholders may want some kind of veto right or qualified voting on certain issues. After all, they will have invested a lot into the business and so should gain some rights in this area.

How and when will the shareholders exit?

Often the dream scenario is to find a buyer that wants to buy the business for a huge price but unfortunately the reality is often quite different. If a satisfactory buyer cannot be found sometimes shareholders can disagree as to whether it is the right time to sell or not.

If one of the shareholders wants to stay with the business to grow it or hold out for a better offer then they can very often stymie a sale. A potential buyer is likely to only want to buy 100% of the business and therefore you would need all of the shareholders to agree on a buyer.

To try and avoid one shareholder holding the others to ransom, the shareholders should agree upfront if there are any situations in which they could be forced to sell if the majority agree the time is right.

Conclusion

Most growing businesses end up being owned by multiple people, whether they are the founder(s), investors or management shareholders and all of these owners can have different goals and priorities. Unless these differing views are considered at the time that the parties join together they can cause real problems down the line.

This article was provided by Elemental Cosec, who provide corporate secretarial services. They are experts in advising on these matters and drafting articles of association and shareholders’ agreements so please get in touch with them if you have any questions.

Elemental CoSec
Elemental CoSec is one of the top company secretarial firms in the UK, providing company secretarial services, administrative services and corporate services to a range of companies from small start-ups through to listed PLCs.
Elemental CoSec

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