Protecting your business from "what ifs"

Often, it’s not until they experience such a situation, or see someone else they know do so, that they appreciate the real value in thinking about, and planning for, the “what ifs” that can have a material impact on their business.

So how can you protect a business?

Clearly legal documents won’t prevent a fall out, but they can materially reduce the impact of a fall out on the business in two important ways:

• First, just the process of discussing what would happen “if” can really help to identify potential issues which can then be resolved before ever escalating into a problem
• Secondly, if a problem does arise, the method of solving the problem is already set out

It’s much easier to agree the solution before the problem arises.

What are the potential “what ifs”?

The typical issues that can arise include:

• Falling out between shareholders or board members – any disagreement between key individuals can start to impact a business, often leading to decisions not being taken appropriately and causing tensions within the workplace.
• A shareholder who wants to exit – when a shareholder wants to exit this may mean the business has to find cash to help fund the exit. This isn’t always easy and negotiating the terms can be tricky if there’s no agreed process of what will happen.
• Divorce of a shareholder – at the very least this can be a big distraction for a business, but it can also mean the business has to find cash to help the shareholder settle financial claims, or it may mean shares have to be transferred either to or from the divorcing spouse.
• Disagreements on the direction of the business – some may want to invest and grow the business or move into new markets, while others are keen to maintain the status quo and not take risks or seek external investment.
• Disagreement over the distribution policy – shareholders not working in the business may just want a return on their investment and may not agree to reinvest profits, alternatively shareholders may just have different objectives.
• Arguments over succession of ownership or board appointments – succession can be a difficult topic, especially for a family business. Must it be a family member that takes control or someone external? Do you have to work in the business to have shares?
• Involvement of family members – do family members have a right to employment or shares in the business?

The list can go on and the solution to each will vary on the circumstances and existing ownership structure of the business, but the impact of each of these issues can be addressed through a combination of a family charter, shareholders’ agreement and bespoke articles of association. Not all these documents are needed in every case, but each have a role to play in different circumstances.

A family charter

A family charter is a document that sets out the relationship a family has within its business and sometimes more widely with their family wealth. It’s a private document and is often not legally binding, as it covers more principals rather than legal obligations.

The parties to a family charter will not only include shareholders, but wider family members who may be employed in the business or have an expectation of becoming a shareholder one day, or perhaps are a beneficiary of a family trust that owns shares. A family charter will cover a wide range of topics, including:

• The family’s long-term ambitions for the business – will it always be a family-owned business; will it always maintain its current location; will it follow certain ethical guidelines; does it have a role in the local community if it’s a key local employer?
• The family’s engagement with the business – will a family member be on the board of directors; will they be entitled to get a job in the business and on what terms; will they be encouraged to seek experience in other businesses first; what sort of qualification will be needed before they are considered eligible to join?
• It’s helpful to set out how a family will interact with the business – will they be given a copy of accounts and budgets; will there be an annual meeting to report on the business results; will non shareholders be able to attend? For large families it may be appropriate to elect a smaller family, council that monitors board performance more closely or perhaps elect one member to have a position on the board.
• An important topic will be ownership of shares – should this include spouses or be restricted to family blood line; can shares be transferred and if so, to who; can non-family members hold shares, such as a non-family managing director or non-executive? Connected to this will be the importance of protecting family wealth and whether there’s an expectation family members will have a pre or post marital agreement, for example.

A family charter can be a really useful document for large family-owned businesses or businesses where a family has a material stake. It provides clarity for all the family on what’s expected of them and what they can expect from this key family asset. Managing expectations can really help to avoid disputes.

Shareholders’ agreement

A shareholders’ agreement is a legally binding agreement between shareholders that sets out how shareholders will interact with each other and with the company. They also tend to be a private document, like a family charter. They can cover similar topics to a family charter, but given they’re legally binding, they tend to be more focused on matters that benefit from a formal agreement. A shareholders’ agreement can set out how the shareholders will exercise their voting rights. Company law may dictate what shareholder approval is needed for certain actions that a company may wish to take, for example, a special resolution is needed to change the articles of association, which means 75% or more of the voting rights have to approve the change. But shareholders can agree that a change can only happen if all the shareholders agree to it, or if the board of directors have authorised the change.

Under company law, the directors have day to day management of a business, which actually gives them extensive powers. For a widely owned business, this level of control given to directors may not be desirable and shareholders may prefer to be consulted on certain big decisions, such as taking on debt or reinvesting profits. A shareholders’ agreement will often set out the decisions (commonly referred to as “reserved matters”) where the directors need to seek the shareholders’ approval before proceeding.

One common area for potential dispute is the distribution and/or reinvestment of profits and setting out a distribution policy is a great way to avoid disputes. A shareholders’ agreement canestablish the financial principals on when profits are retained and reinvested and when they will be distributed to shareholders. This can particularly help the board with setting budgets and a long term investment strategy.

It’s also a good place to set out the mechanism for dealing with disputes.

Articles of association

A company’s articles of association is the internal rule book for the company. It sets out the relationship between a company, its board of directors and its members. It’s a public document, as a copy of the current version must always be filed at Companies House and can be downloaded by anyone. A company is also governed by company law and the articles will reflect a lot of that law, but they’re also capable of being quite bespoke.

The articles will include rules around:

• How the board will be appointed or dismissed and how they make decisions
• Share rights
• Share ownership (what is or isn’t a permitted transfer and circumstances when shares must be transferred)

Conclusion

Planning for potential disputes can often be given low priority, until a problem arises. It’s a bit like paying for insurance, you only really value it when you need it. As lawyers, we see many situations when having good documents that set out the procedure for making decisions or taking the necessary steps to deal with an issue would have saved time, costs and, most importantly, unnecessary pressure on a business and its owners.

For guidance on managing your business, read our latest owner managed business special edition of Private Affairs.