In a perfect world, every company has a shareholders’ agreement to set out what happens if the shareholders later can’t agree on how to run the company. This is especially so in a “50/50” company where two shareholders have 50% each, a director each and a limitless potential for future deadlock.
If, however, there is no shareholders’ agreement, how are 50/50 shareholders going to resolve disputes? Say for example:
- One shareholder wants to reinvest the dividends for growth, the other wants dividend payments.
- One wants to sell the business, but the other wants to keep it.
- The business does not live up to the expectation of one of the parties.
These issues arise in companies, in unit trusts and in incorporated joint ventures, so in this article:
- “Shareholder agreement” is usually interchangeable with “unit holders’ agreement,” or “joint venture agreement,”
- “Shares” is usually interchangeable with “units”, and
- “Company” is usually interchangeable with “unit trust.”
Imagine the situation where each owns 50% of the company and each of them is a director of the operating company. The shareholder meetings are deadlocked and the directors’ meetings are deadlocked. The company becomes ungovernable, the business suffers and no-one can see a way out.
Why Does this Happen?
Should you have a 50/50 relationship at all? Given the number of issues that arise, the answer is “probably not.” Many people only go 50/50 at the outset because they are afraid to take the plunge all by themselves. VC Mark Suster cautions against making a 50/50 offer to a partner at the outset:
- “Even if you *think* you know them, people change. One person gets more risk averse, the other has more risk appetite. One person gets married or has kids and starts to de-prioritize the business. One person loses the passion for what you do. Or you have disagreements about strategy, recruiting, funding, etc.”
Suster is probably right. Here is a partial list of the usual reasons for deadlock in 50/50 companies with no shareholders’ agreement:
- One shareholder does not contribute equally to running the business.
- The shareholders misunderstood each person’s role and requirements.
- Differing expectations for the performance of the business.
- Excessive remuneration being paid to one director to the detriment of the other.
- Excessive remuneration being paid to both directors to the detriment of the business.
- Insufficient access to company information, management accounts or cashflow forecasts.
- Shareholders being locked in without prospect of an exit.
- Lack of communication.
- Lack of control over spending by the other director.
- Shareholders getting involved in a competing business.
- No market for the shares after all the years of sweat and toil because of the 50/50 issue.
First Stop: Always Read the Documents
Even if you don’t have a shareholders’ agreement, always look at the documents that you do have. In Australia, for example, the company constitution is set out in the Corporations Act, except if you replace it with a constitution of your own (which most people do). So read your company constitution or the Act for guidance.
Many constitutions are drawn up on the basis that shareholders in private companies want to have control over who they have as shareholders. Most of the time, then, if a shareholder wants to sell his or her shares, he or she has to offer them to the others in proportion under the constitution or the Act. If one shareholder wants to issue more shares to themselves or to third parties, those shares again usually have to be authorised at shareholder level and/or board level and then offered to the other shareholders in proportion to the shares they already own. So their is often no real prospect of diluting the other party out of their 50/50 holding.
Negotiate a Shareholders’ Agreement Anyway
Just because you didn’t get one at the start, there is no reason that you can’t negotiate one now – except of course if the relationship has broken down to the extent that you can’t negotiate anything. If you are still talking, you can agree all the things that are at issue, for example:
- Day-to-day responsibilities.
- Who has access to the bank accounts.
- How each party can get out of the company.
It probably won’t be as easy to negotiate as it would have been at the beginning, but it is worth putting this suggestion on the table if both parties want the relationship to continue.
Appoint an Non-Executive Director
If you can’t negotiate a shareholders’ agreement, then you might be able to agree a non-executive director (“NED“). This is sometimes a good solution, so long as:
- you have $75,000+ to pay for a good NED for eight or so board meetings a year, and
- your company is solvent (good NED’s don’t like taking on directors’ liabilities for insolvent trading, even for $75,000+).
NEDs do not take part in the day-to-day management of the company and they act in an advisory role only. They are usually known for their ability to act in the best interests of the company rather than the individual shareholders and for being impartial. Once they are on the board, they will have a vote that they will exercise in the best interests of the company rather than in the interests of one or other of the shareholders. This could go either way for either of the original shareholders, though, so make sure that the course of action you want the company to take is squeaky clean.
Issue a New Class of Shares to a Professional Advisor
The appointment of an NED seeks to solve the deadlock issue at the board level. It still leaves a 50/50 problem at the shareholder level.
One way to solve the shareholder level issue could be to issue shares to a trusted and impartial professional advisor (lawyer, accountant, etc.). In this way, shareholder voting is not deadlocked.
Appoint an Expert to Decide
For deadlocks over particular issues, the directors or shareholders could agree to appoint an expert on those issues and agree to be bound by their decision. If the disagreement has gone beyond single issues and the company has become unworkable, however, you will h have to explore more drastic solutions.
No-one ever went into business planning to have an argument, but an argument is what people end up with a lot of the time. This article sets out some commercial solutions that might be useful in the early stages of a disagreement. In the following posts we look at methods of selling shares or having the company buy back shares. In the final article, we look at “end of the road” type solutions such as mediation, arbitration, court action and winding up.