Business Pre-Nups: Not Just for Rock-Stars

Most business owners have either heard about shareholder agreements or have been told they ‘need’ one without really understanding what they are or why. You could be forgiven for believing the many rules in the Corporations Act or your constitution serve you well enough without any employing any further prescriptive terms into your business structure.

In short, why should you bother?

Like in most relationships, the answer may not become clear until co-owners have a dispute over a material issue. An analogy that shareholder agreement can be compared with a prenuptial agreement is not entirely unhelpful.

When the relationship is running smoothly, it is easy for owners and management to believe they can, by discussion, negotiation or compromise, overcome any potential disagreements they may encounter in the future. However, this couldn’t be further from the reality. It is not unusual for the opinion of one shareholder to differ greatly to the opinion of another depending on their own financial or personal circumstances, particularly where it involves reasonable capital contributions. Equally, unless members have discussed and implemented a strategy to fund the acquisition of a deceased person’s interest, they may find they are left running the business with a widow(er) who has neither the expertise nor the time to operate the enterprise.

Investing in a shareholder’s agreement makes sound commercial sense. Members and company officers will save time by pre-determining the procedures and outcomes for key events, such as new share issues and transfers, with certainty and confidence in their respective rights and responsibilities not available under their constitution or at law.

The shareholder agreement is tailored to suit the relevant structure, process and clarity required by the shareholders to effectively prepare and enforce their individual business succession plans. We work closely with accountants and business owners to ensure a tax-effective exit structure with the ultimate retirement of the shareholder in mind. In an unplanned exit, for instance the death or career-ending disability of a key person to the business, the shareholder agreement can deliver certainty of process, valuation and funding.

As a “corporate will” the agreements provide certainty of payment and a clear process to determine the value of the departing owner’s interest. For the surviving owner(s), there is comfort in knowing that a valuation and payment process agreed with a business partner cannot be queried by their estate. Commonly the purchase price is wholly or partially funded by insurance or, where insurance is unavailable, it may be paid off in instalments to assist with the continuing owner(s)’ cash flow.

Key tips:

• Shareholder agreements set out the ground rules for how your business will deal with succession, disputes, unplanned exits and funding.
• Don’t assume co-owners will ‘go along with’ your pre-conceived (but undocumented) ideas on process and outcomes.
• Don’t wait until you are embroiled in a dispute before turning your mind to your shareholder agreements. By that stage it is too late.
• No shareholder agreements can prepare for every contingency – but a good agreement can prescribe a clear process for determining that contingency should it arise.
• In the case of partnerships or trusts, partnership agreements or unitholder agreements are used to provide the same structure and benefits as a shareholder agreement does in a company.

Note

The information provided in this article is general in nature and does not take into account your own specific circumstances. You should seek the advice of a lawyer with recognised expertise in your industry prior to acting on any of the issues discussed.

If you want advice as to how to establish a shareholder agreement, please contact our Corporate and Commercial team for advice.