BUSINESS PARTNERSHIPS: FROM EXCITEMENT TO DISASTER
Imagine this: you’ve come up with this absolutely incredible concept. Your mind races into the future, envisioning just how amazing it’ll be when brought to life. Your heart races, your chest flutters with visions of your new project. You’re brimming with excitement to kickstart the new idea and you’re desperate to get started – full throttle, right now.
You begin discussing this idea with friends, sounding it out and receiving nods of approval. You’re excited to gather all those positive affirmations – and one particular friend is especially enthusiastic. You think this person could be a perfect fit, the missing piece of the puzzle, someone with whom you could create something even bigger, using their support to make it ten times better. They excel at the mathematical aspects while you’re the creative energy, they’re adept with spreadsheets while you’ve got the kitchen know-how, they’re highly organised while you bring the ideas. They’ve got just the sensibility you require – the yin to your yang.
Your friend is all in and the energy they bring dispels any doubts. They’re a comforting presence as you embark on this journey together. First things first – the shiny details. What’s it called? What’s the logo? Where will it be? What cool ideas can we implement? You plan a launch party complete with branded stickers, gathering all your friends to spread the word.
And so your idea becomes a reality, attracting an enthusiastic audience. The business takes off! It’s booming and soaring – you knew it was a fantastic idea, and people adore it. You find yourself hardly sleeping, but your new business partner is in the same boat. You talk incessantly; it’s like a marriage, but you’re fully committed no matter what.
The money starts rolling in and you both agreed from the outset that whatever you make, it’s a 50/50 split. It makes perfect sense, doesn’t it? After all, it’s just the two of you. Both of you are running on minimal sleep, working tirelessly, and you’re in this venture together.
Everything’s great… but that nagging voice in your head won’t go away. It keeps you awake in the middle of the night. Something doesn’t feel fair – your business partner isn’t carrying their share of the load. The shiny idea is yours, so is the creative vision and the audience that came with it – they’re here for you, not them. Does your partner realise this, or do they just think it’s easy? Do they understand how much work you do? The voice in your head gets louder… it’s your baby, and perhaps you want it back.
It should be a simple matter to resolve – nothing was ever documented, just mutual trust and a rock-solid friendship, so you can just change things, right?! You need to tell them something difficult – you want a fairer arrangement that reflects the real workload, not that 50/50 split that you first agreed. That just doesn’t seem right anymore. You want something different. That doesn’t need to spell the end…?
But in the blink of an eye, things turn sour. You have no written evidence to prove ownership. There’s no shareholders’ agreement – what is that, even?! The distinctions between power and profits become baffling. Why isn’t the intellectual property automatically yours? Before you know it, you’re embroiled in a legal battle, second-guessing your choices and the reasons behind them. Suddenly, you stand to lose everything – your business, your ideas, your vision, certainly your friendship. It’s an uncomfortable, heart-wrenching, and costly situation. If only you had put everything in writing before you embarked on this journey – before you were swept up by all those shiny, exciting things. It could have saved you a lot of trouble.
So how do you stop this from happening? We spoke to legal advisors Leathes Prior to demystify the process, breaking down the whats, whys and hows of getting an agreement in place which will protect yourself, your interests and your business – now and in the future.
Speaking to a third party will have a benefit beyond the purely administrative. It will force you to truly analyse the realistic division of your labour, not just now but in the future, encouraging you to think about the time spent and nature of the work during the initial phases and when the business grows. We have heard too many horror stories about one partner continuing to receive a 50% share (or even more in a couple of cases) whilst no longer having any active involvement; and about intellectual property being claimed or blocked from future use. In short, stories about one person’s hard work unfairly and disproportionately benefitting another, often with significant disadvantage to themselves. A correctly drawn-up agreement will help to prevent this wrongful dynamic – and to avoid disputes or even loss of friendship down the line. Read on to find out more.
When setting up a business, do you need to know the split from the outset? Or can you figure it out later?
Is giving equity away something you can easily get back?
LP: As is the case with most things in a business context, the most cost-efficient way to deal with the ‘split’ of your company’s shareholdings is as soon as possible, ideally at the time of incorporation. If you and your fellow shareholders know the proportions in which the company should be held from the off, your solicitor will be able to tailor your company’s core legal documents (such as the company’s articles of association) to fit the bespoke needs of your company from the beginning. This will also allow you the most control over the direction of your company moving forwards, as the company’s decision-making structure will be in line with your wishes from the very beginning.
If circumstances change following incorporation, it is possible to change the split of shareholders through issuing new shares (which the company is paid for) or the transfer of shares between existing shareholders. However, as mentioned in the answer to question 2 below, taking shares back from someone is not necessarily straightforward, so it is worth bearing that in mind when deciding on the initial split of shareholders.
Giving equity in your company away in exchange for outside investment is a very useful way to facilitate a cash injection when your company might need it most. However, getting that equity back (for example, because a shareholder is no longer involved in the business) can be a challenge if you do not set up the company’s constitution to require that person to transfer their shares.
Once issued, shares are as much that person’s property as any other physical possession they own. The default position is that a person can’t be compelled to sell them if they don’t want to do so. To get around this issue, companies will often include clauses in the articles of association which require a shareholder to offer their shares for sale in a variety of circumstances, including where that person leaves the business.
Before issuing any shares, it is worth considering whether there could be circumstances in the future in which you would want to get them back, and taking legal advice on how this could be achieved.
Is 50/50 ownership a good idea?
It is not hard to see why a 50/50 ownership split is often the first (and sometimes only) option to be considered when two people start a company together. Often, partners behind a company have put in equal amounts of time and effort and are equally responsible for the company getting off the ground – it would only seem fair for both to hold equal ownership of the company.
Whilst beneficial from this perspective, there are some significant practical implications to such a split; most notably, what happens in the instance of ‘deadlock’? The default position where two shareholders clash with each other on an issue, where they are 50:50 shareholders, is often that nothing gets done – with neither shareholder able to exert a majority vote on the other.
However, this does not mean that either shareholder should needlessly give up ground in terms of ownership. A well drafted shareholders’ agreement that provides for circumstances of deadlock (amongst other things, which may prove useful to the company down the line) can resolve these practical difficulties – meaning both shareholders can have their cake, and eat it too.
What is a shareholders’ agreement and why is it important?
As touched on above, a shareholders’ agreement is essentially a central company document which sets out the rights and obligations of the shareholders – not just to the company, but to each other. It is also a private document, which does not need to be a matter of public record (unlike a company’s articles of association, for example).
Where shareholders are in complete agreement on every course of action, a shareholder agreement might not prove particularly useful. However, as anyone who has experienced the difficulties that come with running a company will attest, this is rarely the case. Indeed, the more shareholders there are, the more susceptible the company is to shareholder conflict.
In many ways, a shareholder agreement can do whatever you want it to do – from dictating who may become shareholders in the company in the future, to protecting the rights of minority shareholders. As a result, your shareholders’ agreement will only be as good as the lawyer you instruct to draft it, as they will be able to advise on the many angles you might take so as to have as functional and helpful a document as possible.
What are the questions that me and my business partner should be asking each other when setting up our business?
When should you put a shareholder’s agreement in place?
The temptation in the early days of setting up a business can be to reserve discussions about your business to the exciting stuff – whether this be about your visions for the future of your brand, or perhaps even your exit strategy. While it can be less pleasant to do so, an equal amount of time (if not, more) would not be poorly invested into discussing the fundamental characteristics of your business – to cover this off sooner is to avoid potential points of disagreement in the future.
In particular, it would be worthwhile to discuss your corporate structure, your split of control over the company, and your processes for decision making – the areas that can have costly consequences if left unconsidered. An early discussion of these topics can also pave the way towards formalising any conclusions you come to in your shareholders’ agreement and articles of association, providing you with that additional level of protection moving forward.
The short answer is – as soon as possible.
The longer answer is – as soon as (a) you and your fellow shareholders have had time to discuss and consider how you would like your company to be run, (b) you have had an opportunity to obtain legal advice on your rights as a shareholder individually, and (c) you and your fellow shareholders have had an opportunity to obtain legal advice on how best to put your collective decisions into effect.
A shareholders’ agreement is best put into place at a time when the shareholders are in general agreement on the running of the company. While this might be the case today, there is no promise that it will continue to be the case tomorrow – and that is exactly when the shareholders’ agreement demonstrates its true value.
Can you get one drawn up later down the line?
The option to have a shareholders’ agreement drawn up at a later date is a door that only closes where the shareholders cannot agree what form such an agreement should take.
With that considered, there is technically no date where the door shuts completely – however, the risk of such disagreement arising increases as time passes.
What is the difference between sharing profits and having ownership?
The difference between sharing profits between shareholders and sharing ownership with other shareholders boils down to the details of your company’s constitution.
Your typical shareholder will have an entitlement to both – a portion of the profits and a degree of control that is proportionate to their shareholding. As such, it is easy to get the two confused.
However, it is possible for:
- A person to have a share of the profits, but no ownership of the company (which can be achieved, for example, through issuing shares which have rights to receive dividends, but no rights to vote or receive any sale proceeds if the company is sold); and
- A person to have ownership of the company, but receive no share of the profits (which can be achieved, for example, through the issuing of shares that do not attract a ‘dividend’ – or share of the profits).
In truth, when discussing the structure of your company with your solicitor, your options for customisation are vaster than you might realise. As a result, your solicitor adds real value in narrowing your options to those that suit the characteristics of your business, ensuring that your decisions are in the best interests of both you and the company.