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Business Deadlock and Beyond – The Risks of Not Having a Shareholders’ Agreement

Written by Jon Cooper

A new business starts on a wave of optimism and enthusiasm whether it be to pursue your dream, to develop a new product or to leverage your talent.

In many cases, the business is incorporated into a Limited Company with a friend, colleague or partner to share the journey and it seems only fair to divide the shares on a 50:50 basis.

Unwittingly, by adopting this structure, you have both just created the potential for deadlock which could have dire consequences in the years ahead.

Like relationships in life, a business relationship can breakdown with irreconcilable differences. If the fall out means that neither shareholder can agree on the business strategy, the company is in deadlock and no decisions can be advanced.

Whilst there are remedies, it is important to recognize that this situation is not catered for in the model Articles of Association when the company is incorporated.

Deadlock is damaging for any business but particularly in the early years where finances and deliverables tend to be tight and the reputational harm can be irreparable.

Should you end up in this unwelcome situation, it is vital that you take action as the future of your business is in peril. The problem is that the remedies at this stage are likely to carry a punitive cost whether it be initiating a court action or seeking to injunct a formal negotiation process.

The first step is to engage a commercial lawyer to advise you of your rights and steer you through the process.

However, this could all have been avoided at the outset by putting a simple Shareholders’ Agreement in place as part of the overall business set-up process.

A Shareholders’ Agreement is a private contract between the parties unlike the Articles of Association that are in the public domain. As such, it provides a framework to formalise a process to resolve a deadlock discreetly.

A Shareholder’s Agreement is also platform to define in detail the rights and the responsibilities of shareholders with regards to the management of the business, the treatment of shares and dividends and their exit strategy.

Another risk from deadlock is that it will lead to diverting profits. It is important to be aware that, whilst the Directors have a fiduciary duty to act in the best interests of the business this does not automatically apply to shareholders. As such, without a Shareholders’ Agreement specifying otherwise, there is nothing to prevent a shareholder establishing a competing business and plundering your business’s employees and customers and, effectively, diverting your profits.

As a Shareholders’ Agreement is additional cost at the time when the business is a kernel of an idea and all-consuming, plus it can be perceived to infer a lack of trust, all too often the founders defer or ignore the issue.

The reality is that there is no better time than the early days to address this whilst the plans and expectations of the founders are fully aligned and the business structure is straightforward.

‘Kicking the can down the road’ invariables results in a costlier Shareholders’ Agreement both as the business matures and adds complexity and as views diverge.   On the occasions when deadlock occurs it is too late!

At CooperFaure, we can guide you through the issues that you need to consider and prepare a Shareholders’ Agreement for your business. For further information, please contact us at tax@cooperfaure.co.uk.

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