Do you have a blind spot in your business about the nature and effect of the business relationship with your business partner? Do you understand the risks that that might be creating? At what point would it be sensible to address those risks?
Background
We recently acted for a minority shareholder/director of a multimillion pound turnover company who was able to resign his directorship, set up a competing business and walk off with his former company’s main customer because there was nothing in the contractual arrangements with his business partner which prevented him from doing so. Whilst this was a situation which operated in his favour, (because he was the individual departing), he might not have been so happy if he had been the individual remaining in the business.
How did the situation arise?
The shareholders had been trading happily together for several years. The company had reviewed the contracts of employment with all staff and had required them to enter into sensible restrictive covenants so as to protect the business if any of them left. For some reason, neither Director thought it appropriate to require the other to enter into a Director’s Service Agreement with similar obligations.
In addition, although the parties had been trading together successfully for a number of years, they had never entered into a shareholders’ agreement (which might have contained similar restrictive covenants). As a result, when the relationship deteriorated, there was nothing in place to protect the value of the continuing business.
When should these issues be addressed?
The difficulty can be to determine when it may be appropriate to consider entering into these sorts of arrangements. For some businesses, with more modest ambitions, it can be more sensible to spend the early investment on sales and marketing so as to ensure that the business model has some traction and is successful.
For those businesses with a more established business model and with longer-term ambitions, it may be appropriate to get the paperwork in place at the outset and ensure that there is a proper shareholders’ agreement as well as proper Directors Service contracts on offer before they commit.
Where all shareholders have an equal number of shares, discussions about the benefits of such arrangements have an interesting dynamic: each party needs to consider the arrangements on the basis that they might be either the party that remains or the shareholder wanting (or having) to leave. It encourages the parties to take a balanced approach whilst maintaining some form of emphasis on protecting the business.
Recommendations
If you are a shareholder in a small business which has built up some goodwill and in which the shares have some value, think about how to protect that value for the business and think about whether the steps you have taken to protect your own investment are sufficient.