Why are shareholder agreements so important?

Going into business is always incredibly exciting. A new journey begins with high expectations that your life will change for the better, that your new business will deliver freedoms through the profits it will generate and you’ll have the opportunity to pick and choose what you want to do.

This excitement can be enhanced by the fact that you are going into business with a friend, someone you have probably known for some time and may be worked closely with.

Take Tom and Mary. They have worked for 10 years in an online retailer/wholesaler selling scuba diving equipment to the public and to specialist trade shops and clubs. They know the business inside out with Tom being a buyer and sales rep and Mary an expert on website sales.

The mood is great. Tom and Mary have set up a 50:50 company and visit their accountant. He helps them get set up and advises them to take time to sit down and work out the rules that will govern their ongoing business relationship. These will be documented in a shareholders’ or partnership agreement.

Tom and Mary look at each other. “Hold on, do we really need an agreement? We know each other. We need to crack on and make this business a success. We haven’t got time to waste on an agreement. We know what we’re going to do plus we’re worried about the cost!!!! We can’t really afford a solicitor or extra accountancy fees to get this set up at the moment.”

So they decide to ignore the advice.  Time moves on and their website is soon up and running. Sales are slowly coming through. Mary is working 60 hour weeks developing the website, placing products on to the site and marketing. Additionally she’s in the warehouse picking products and parcelling them up for distribution. She’s also doing the book-keeping and countless adhoc admin duties. Tom is around some of the time and helps out in picking products but spends most of his time with suppliers looking for new products and visiting trade customers. Mary feels that there is never enough time in the day. Tom seems fairly chilled about things. Financially everything seems to be going well. They take their dividends and salary.

But Mary is getting frustrated. She asks for a meeting with Tom and they sit down and talk. “I need help” says Mary. “I need you to either help out more in the warehouse or take over some of my work. Failing that we need to get someone new in”.

Tom looks at Mary and says “We can’t afford it. I’m really busy sourcing the products and finding new customers. We’re doing well and I need the money. Let’s keep going and review things in a couple of months’ time. If we can get more business in and can afford it we’ll get someone then”.

Mary argues, but Tom just says no. Mary is frustrated but gives in and they get back to work. Soon Mary is working 70 hour weeks! Then one day Tom gets a phone call from Mary. “I’m ill – I have to take a month off work.“ Tom gets to work in the warehouse picking products and parcelling them up for distribution etc… He quickly gets some outside help in! Business deteriorates as he is unable to do everything. Customers start to complain as mistakes are being made. Profits fall.

The end of the month arrives and Tom takes his salary and his dividend. Mary calls “Hi Tom, I didn’t get my dividend this month?” Tom feels uncomfortable but says “Mary sorry we can’t afford it and I’m doing all the work”.  “You can’t do that” says Mary. The resentment on both sides starts to grow.

Mary returns to work and instantly asks for a meeting with Tom. The finances are looking bad. Mary tells Tom “We need a plan and we need to invest more money into the business. I’ve spoken to the bank manager and we can get a loan but we’ll have to give personal guarantees”. Tom says “No way and to be honest I’m not enjoying this. I’m going to get a job elsewhere. As we’ve built the business up I want £50,000 for my shares. I think that’s fair given the effort I put into the business”. Mary looks dumbfounded. “You can’t just do that”.

What happens next? Well it won’t be pretty!

The problem was not just that there was no vision or plan for the business but crucially there was no shareholders’ agreement.

A shareholder’s agreement can include many things, but the following would have proved particularly useful for Mary to hold Tom to account:

1. Details of the number of hours they should work and their holiday entitlements.
2. Their respective roles in the business.
3. Their remuneration packages.
4. What happens if one party is absent due to unforeseen circumstances such as illness.
5. Who is the managing director or CEO to ensure that decisions are made or clauses to deal with deadlock.
6. What issues will always require a unanimous decision.
7. What happens when someone wants to leave the business, falls ill long-term or dies.
8. What happens if someone wants to sell their shares.
9. What happens if there is an offer to buy the business.

Setting out what is expected from each party from the outset and having provisions for future scenarios is key and helps avoid disputes at a later date.

The above was an example of a 50:50 company but the same applies for any company in which there are more than one shareholder.

If you need help make sure you speak to your business advisor. At Friend & Grant we have been involved in numerous shareholder agreements and can work with you to assist in preparing an instruction for your solicitor to complete the shareholders’ agreement. Why come to an accountant first rather than the solicitor? A lot of issues can be addressed early on through the careful structuring of the company e.g. alphabet shares and ensuring the articles are prepared correctly. However, we would still recommend a shareholders’ agreement is put in place. Having worked with thousands of businesses we can discuss what is really essential in the agreement and the basis for the valuation of any shares in the different scenarios. Your shareholders’ agreement should be unique to your business and meet your specific needs. We have the expertise to help you get the right agreement first time.

Here is our video explaining what are shareholder and partnership agreements.

The content in this blog is correct as at 30/11/2020. See terms and conditions.