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Starting up a new business

By Andrew Oh, Associate

First published in The Press, 18 March 2008

At the start of a business, partners typically see eye-to-eye and this is the best time to agree on how the business is to be run. This principle applies no matter what type or size of business you are looking at.

While there are various forms of business structures, such as   unincorporated joint ventures, partnerships or trading trusts, the most common vehicle is a company. In the case of a company, the results of these discussions about how to structure your business will be recorded in a Shareholder Agreement. While the guiding document may have different names for any other structure you may choose, the principles are the same.

A well thought out Shareholder Agreement is the most significant building block on which to start the business. Shareholder Agreements tend to deal with three main issues: entry; management; and exit strategies. It is vital to agree on how you will enter into the business, how you will manage the business and how you will exit the business.

Shareholder Agreements are an important record of the relevant parties' agreement at the start of the business. It is a time when you can agree on the right approach, philosophies and vision for the business. While a Shareholder Agreement is not a guarantee of success, by ensuring all parties enter into the business in harmony on how issues are to be dealt with, it reduces the odds of incompatibility with your partner on fundamental issues. It is also a time that parties can realise they are incompatible before having made a large financial commitment.

The issues discussed and recorded in shareholder agreements fall within areas of governance and management, capital and funding, director and employees, entry and exit of shareholders and deadlock and default.

While they are all important, the issues surrounding deadlock can help in alleviating fallout between partners. Procedures agreed to at the start on how to deal with any deadlock between the parties are vital to giving the business the best chance of surviving during shareholder disputes. There are various deadlock breaking mechanisms available such as Russian roulette, shoot out, take out and put and call options. Deciding on the appropriate mechanism requires balancing the relative financial and commercial positions of the parties. The great thing about these mechanisms is it encourages parties to try and resolve issues. They cannot just ignore or delay discussions as the alternative is that one of the mechanisms will be brought into play to force resolution. This will most likely result in a less favourable situation for everyone.

No matter how good your business is, it will no doubt face challenges and difficult decisions will need to be made. At this time, one of the biggest threats to the viability of a business is disagreement among its shareholders. Such disputes, if unresolved, can very quickly destroy a business. Deadlock mechanisms tend to push parties into reaching agreement by compromise as the alternative is far less palatable. If these mechanisms were not available, going to court may become the only alternative and the costs of litigation can be crippling for the business and shareholders alike.

Many prospective business owners feel that they cannot afford to spend money on professional advice, whether it is legal or accounting. But from what we see in the trenches, getting professional advice at the beginning tends to save money and increase the efficiencies of the business. Putting in place a good Shareholder Agreement will go a long way towards giving you peace of mind that management level issues have been dealt with and that you can focus on the day to day issues that will make your business successful.