Shareholder Disputes: Planning for the Worst – Episode 2

Are you a business owner? Don’t leave your company’s future to chance. In the second episode of our podcast series on shareholder disputes, we explore what happens when business partners disagree—and why a robust shareholders’ agreement is essential for protecting your business from costly conflicts and complicated breakups.

Join hosts  Stuart Mullins, Corporate Partner at Clarkslegal, and Nicky Goringe Larkin, founder of Goringe Accountants, as they share practical insights, including:

• How a shareholders’ agreement protects your business
• Why mediation should be your first step
• The financial and emotional impact of dissolving a company through the courts
• Tips to secure your company’s future and goodwill

Whether you’re launching a start-up or looking to reinforce an established company, this episode delivers advice every business owner should hear.

To discuss any of the topics from this episode, please reach out to Stuart Mullins or Nicky Larkin—they’re ready to help.

Transcript

Stuart Mullins   00:07                                                                                                  Welcome, everybody. Welcome to the second in a series of podcasts on shareholder disputes and how to avoid them. In our first podcast, we talked around the sorts of instances that can give rise to a dispute. And we concluded by saying that we're really not focusing on disputes per se, but instances that can give rise to a passing of the ways of shareholders. How those situations can arise. This second one that we're doing will focus really on, how to avoid those shareholder disputes. How in our experience you should act if these instances arise and also a word for the cautious where they can ultimately lead.

I'm Stuart Mullins, I'm a corporate partner at Clarkslegal and I'm joined by Nicky Larkin again today. Nicky Larkin being the founder and managing director of Gorge Accounts and Business Advisory. Hi, Nicky

Nicky Larkin   01:22                                                                                                              Hi, good to be here.

Stuart Mullins   01:24                                                                                                    Thank you. Thank you for joining us. I think we can answer where might they lead. That element of our theme today, Nicky, quite succinctly. I mean, ultimately, where two of all parties fall out and there's no clear route or resolution. The only option is to petition the High Court for a just and equitable winding up of the company, which is a long-winded way of saying that you're going to the court, you're asking the judge to make a decision that the business should be dissolved. That all the creditors are duly paid, and any money that's left is split proportionately between the shareholders. And of course, that in and of itself is an expensive, time-consuming process. And for a founder, it's very difficult to realise any goodwill out of that kind of application. Everybody kind of takes back what's left and moves on with their lives, which is a sad way to end your business, isn't it, Nicky?

Nicky Larkin   02:35
Yeah, indeed. And generally, nobody wants that to happen. That's, you know, the nuclear option, you know, as you say, goodwill will be destroyed generally in that scenario. And as the director, you know, it's their duty to do the best thing by the company. And in most circumstances, that won't be the best thing for the company. It will be for it to carry on trading in some sort of form. So, you know, obviously that is an option if all other routes fail, but, you know, that may shake up the directors to come and come to the table and try and work on the other areas.

So, I mean, I always start off with mediation to try and see if there are any common consensus to see if, you know, what is the underlying actual issue to see if we can get there first. And then, you know, then we would go to other routes that we could go, which you might want to start talking about, rather than going to the High Court.

Stuart Mullins  03:47
Yes, Nicky, thank you. I think that's absolutely right. We touched on it in our first podcast in the series that there no statutory routes to resolution, if you like, in these instances. Your shares of property, you own them, you can generally do what you like with them. So one of the ways that you can avoid a lot of this is by having a shareholders' agreement. A shareholders' agreement is a contractual document that sits between the respective shareholders and contains a blueprint for what should happen to shares and share ownership in the event of certain things. And those instances are generally in the event of a shareholder wanting to cease to be a director. If a shareholder becomes too poorly, to work if a shareholder becomes incapacitated or dies, what happens to those shares is prescribed as a say in a route. And typically we have what we call contractual rights of preemption in shareholders agreement that's set out very clearly an order of compulsory transfer, who's entitled to partake in that share transfer, how the value of those shares is determined, and ultimately allows the company to buy back the shares in the event those other shareholders don't want to partake in the acquisition of the shares on offer. And as I say, I think most advisors will accept that if you don't talk to people setting up a business at the outset about shareholders agreements, that the advice can be questioned. I think they're pretty entrenched. And whenever I talk to my clients about them, I explain they're a form of insurance really in a similar way to a prenuptial agreement or a postnuptial agreement you might have in matrimonial situations that you sort of, you know, you plan for the worst and hope for the best. You prepare these agreements and you put them in the cupboard and you hope you never look at them again. And the other areas that they are useful, one is in addition to compulsory transfer events or rights around shareholders looking to leave or deemed to have left the business, you can have quite robust restrictive covenants that preclude solicitation, competition of key people, key shareholders in the business, in the event that they do leave. And they are generally seen as a lot more robust than you'd see in service agreements. And thirdly, as you alluded to, Nicky, they normally contain a sort of falling out alternative dispute resolution slash mediation provision that sets out how they're going to sit down at first instance and try and work through any issues that may well arise.

Nicky Larkin   07:08
Yeah, absolutely. There's a couple of things from there that you want to make sure are within your agreement. One is the method and who would be preparing potential valuations of the business. It could be that you actually have the formula, within the document itself. For some sectors, that's quite simple to have that in there. For others, you might just have, say, OK, some independent third-party valuer will be commissioned to prepare that valuation. But also, so that's really important to have how that actually happens in the document. But also having time frames in there is really key as well, because you don't want to become a long, protracted process, because usually the longer that this takes, the more detrimental it will be to the value of the business. So having some sensible turnaround times for these things to come to agreement is the best thing for the business.

Stuart Mullins   08:12
I think I think that's absolutely critical. You've got to think through these timelines pragmatically when you're looking to draft these agreements. And the other thing about them is that They are considered by many as a sort of ‘Will’ for the company. By that I mean, as you should do with your own affairs, is re-evaluate where you are in life every five years or so, and consider whether or not the document needs to be amended or reconfigured to reflect the goal, growth and maturity of the organisation. And by that, I mean, you may well have different types of investor, you might have different types of shareholder, you may well have different classes of share. And the valuation model that's included that was fit for purpose in the first or second year of the business's life cycle may not necessarily be the right one for the founders by the time you get to years four and five, Nicky.

Nicky Larkin   09:15
Yeah, and one thing we touched upon in the last podcast is something that many business owners might not even have come across or understand how it could be implemented is a merger. So in some instances, it won't be appropriate for all circumstances when. But if, for example, there were two business owners in there, there was Stuart and Nicky, we've had a little barney, we've fallen out. However, we still like parts of our business, and we want to carry them forward. So it could have been that for the Stuart and Nicky show. That we go, well, Stuart, you take on these clients, Nicky takes on these, and therefore we demerge them. So it might be by clients, it might be by sectors. If it's a property business, you might be splitting it by the different properties into the two different demerged businesses. So that is another way so that both can carry on trading in new entities, but with the content of what they liked working on beforehand. It's not a very, very common thing, but it is a possibility.

Stuart Mullins   10:31
But. That's right. It's certainly in my experience, Nicky, where you have businesses that have multiple revenue streams. We have different founder shareholders heading those different streams, where you have different or self-contained businesses self-contained over a number of different geographical sites. It's a very neat way to resolve the issue. And I think I'm right in saying, but I will defer to you, that there are some tax…

Nicky Larkin   11:00
Yeah, it's a tax-efficient way to do it. I think that's what you're looking for. 

Stuart Mullins   11:04
Yes, efficient ways of restructuring, thank you, of restructuring your business in demergers. But I would say that my experience are that the is very much that the rules are complicated. If you are going to go down this route, you do do please go and take advice from a competent professional like Nicky. Make sure you explore the necessary clearances. Make sure you are aware of the rules to benefit from that route. You do not want to trigger for the wider group unnecessary tax implications. It is.

Nicky Larkin   11:39
Absolutely, absolutely. You always want to have proper HMRC clearance for these scenarios. So you need to go into proper detail and get these done properly. So yeah, definitely always get bespoke advice for your circumstances.

Stuart Mullins   11:55
Yeah.

Nicky Larkin   11:56
Yes.

Stuart Mullins   11:58
Well, that's great, Nicky. Thank you. I think that draws us to a bit of a natural conclusion of the second in our series. I suppose, just as a recap, how to avoid a shareholder dispute? Well, I think firstly, you should all consider shareholders' agreements, whether they're fit for purpose, and whether they contain appropriate mediation or dispute resolution processes that can avoid lengthy court action. Also, I think it's important for... you to consider disputes in the widest sense of the term. Any instance where you feel that the business may be being pulled in a different direction by certain shareholders and others, it's probably a good time to try and address the elephant in the room. With those people, failing which involve the likes of Nicky at an early stage to see if we can plan a route that preserves that goodwill that you've worked so hard to build up. Well, thank you again, Nicky. Thank you very much. And I look forward to talking with you in our third and final podcast in this series, where we'll look a little bit more around the roots of exit. We'll assume that the issues arising have been resolved, that valuation and quantum have been agreed and building really on the various avenues that are available to ensure that those shares are transferred accordingly so that the business can move on, move on and move forward. So thank you very much for joining us and until next time. Please keep well and thank you for joining us. Bye for now.

Nicky Larkin   13:54
Goodbye!