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It pays to set up properly

By Richard Neave, Partner

First published in The Press 26 May 2009

It’s not unusual for a small business to come unstuck when its owners fall out or want to move on. The trouble is that many problems could have been avoided had the business been properly set up.

Take, for example, this typical scenario.

Pete and Bob started work together as apprentice builders in 1994.  Despite being good workers they were both made redundant in 1999 as a result of the downturn in the building market.  Over a beer one night they decided that, as Pete was good with figures and Bob with people, they would set up in business together. On the recommendation of their accountant, they formed “Pete & Bob Limited” with the two men being equal shareholders and directors. 

The business has gone along well since 1999 and Pete now wants to take on bigger contracts and employ more workers which will involve a significant bank loan.  Bob is not so keen, preferring the company to remain a two person owner-operated business. He doesn’t want to take on further risk.  Pete, however, has said that if the business does not expand he will take up an opportunity to work with his brother-in-law in Australia.

As Bob won’t agree to the business incurring further debt, Pete has offered to sell his shares back to Bob.  But Bob doesn’t want them and, although Pete has been told by his accountant he can sell the shares on the open market, he can’t find a willing buyer. So Pete cannot sell his share and is left with a choice of either remaining in the business or walking away from his investment.  

The problem is that Pete and Bob did not enter into a shareholders’ agreement before setting up the business. If they had, the course of action and their rights would be clear.

Some business relationships are structured as partnerships and other owners incorporate under the Companies Act.  Contrary to popular belief neither the Partnership Act nor the Companies Act provide a procedure for resolution of disputes between owners of a business, nor do they have a procedure when one party wants to sell their interests in the business and move on. 

It is, therefore, very important for people entering business relationships or currently in business together to ensure that they have partnership and shareholders’ agreements setting out procedures, which the parties can follow in the event of a dispute or should one party wish to leave the business.

An agreement can include:

• Referral of disputes to mediation or an independent referee;
• A formal procedure to be followed when a party wishes to sell their interest in the business;
• What happens if the other parties do not wish to purchase the selling party’s interest in the business;
• A method to determine the fair value and purchase price;
• Circumstances in which the business should be liquidated.

There are many other clauses which can be included in a partnership or shareholders’ agreement and which provisions are most appropriate will depend on individual wishes and circumstances.  But it is important that all those involved in a business relationship turn their minds to how any differences could be resolved to avoid a stalemate if a dispute arises or one party wants to move on.

Disclaimer: the content of this article is general in nature and not intended as a substitute for specific professional advice on any matter and should not be relied upon for that purpose.

• Richard Neave is a partner specialising in commercial law at national and trans-Tasman law firm Duncan Cotterill.R.Neave@DuncanCotterill.com; www.DuncanCotterill.com