I am frequently amazed at the number of businesses with more than one equityholder who do not have equityholder agreements.
Usually this becomes noticeable when an event occurs that no one knows how to deal with, and the parties have to resort to lawyers to sort it out.
Take the situation of Eddy. Ten years ago he and his best mate Trev set up business together, as equal shareholders in a company, selling wholesale garden supplies. Because they were mates they did not think a shareholder's agreement was necessary and perhaps, more to the point, they did not want to pay a lawyer to prepare one.
Everything went well for the first six years but then Trev and Eddy's wife, Mandy, took friendship one step too far and Eddy found himself with an ex-wife, an ex-best friend and a very strained business partnership. The business was still quite successful and neither Eddy nor Trev wanted to leave. They somehow kept it going for another two years when Trev suddenly died of a heart attack. Eddy then found himself in the uncomfortable position of being in business with his ex-wife who had inherited Trev's shares. Without a shareholders' agreement, or buy/sell agreement, Eddy had no mechanism to force Mandy to sell the shares.
Because their divorce had been so acrimonious it was virtually impossible for Eddy and Mandy to have a rational discussion about the business, much less make any decisions. As 50/50 shareholders they needed to agree even in order to appoint another director t replace Trev. Eddy would not agree to appoint Mandy (or her brother) as a director. As sole director he decided not to declare dividends and, instead, increased his salary from the company. Mandy's legal advice was to bring proceedings under the Corporations Act for oppressive conduct. This has resulted in large legal bills on both sides and Eddy's focus has, not surprisingly, been taken off the business, which was already suffering from the loss of Trev. This sad situation could have been so easily avoided if Eddy and Trev had entered into even the simplest shareholders agreement, or buy/sell agreement, from the outset, which would have provided for Trev's shares to be bought by Eddy (and vice versa) in the event of death or permanent disability, at an agreed value or using an agreed valuation mechanism. It would also most likely have prompted them taking out some term life insurance to help fund the purchase of the deceased's shares, something Eddy now desperately wishes he had.
A shareholders' agreement would also have saved another SME owner, Julie, a lot of angst and legal fees. When she started her retail homewares business, she offered a 15% shareholding to Maria who was at that time her only member of staff, and who agreed to take a minimum salary for a period to allow the business to be established. The business flourished and after 18 months Julie set up another company to operate a new store on the other side of the city. Because the arrangement with Maria had worked so well for the first store, she offered a 15% shareholding in the new store to the newly appointed manager. . However Maria was upset that she wasn't offered shares in the new store company and believed she was entitled, as an initial shareholder in the first business, to either be offered the same interest in the new business or to have the new business owned by the initial company. She sought legal advice from her lawyer cousin and now threatens to bring proceedings under the Corporations Act claiming that the decision to establish the new business through a vehicle in which she had no interest amounted to an improper diversion of opportunity by Julie to the new company and, therefore, was oppressive conduct against her as a minority shareholder. If Julie had entered into a shareholders' agreement with Maria at the time of establishing the first store, this could have clearly specified that the company existed to operate one particular store and included an acknowledgement from Maria that her entitlement to shares was based upon her being the manager of that particular store, with no automatic right to receive shares in any additional companies that Julie might decide to establish in the future to operate new stores.
We can sympathise with owners of SMEs who are usually under-resourced and reluctant to allocate funds to what may seem to be the discretionary cost of having a shareholders' agreement prepared.
Those with little experience in business cannot be expected to foresee all the typical events that could affect their relationship with fellow equity holders. Because many of these new business owners will choose to avoid a visit to a lawyer and hope that a visit to the accountant will be enough to get the business established, it is often up to us to convince them of the necessity of having a shareholders' agreement. Relating some sobering war stories is a good way to get the message across. Hopefully the sad tales of Eddy and Julie will help convince other Eddys and Julies of the important role a shareholders' agreement can play in protecting themselves, their families and their businesses from each other.