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Why Do Shareholders Agreement Work

M&A-Terminology

Begin as you mean to end. That is an old saying but one that has some genuine relevance to our topic. If I have interpreted this proverb correctly it has a lot to do with having the end in mind when starting out on a venture. But how often do we do this?

Many people starting a new business are understandably excited about the possibilities. The last thing you want to think about is the worst-case scenario; the failure of the business or a partnership that breaks down. However, as you are so often told, failure to plan and lack of funding are major contributors to small business failure.

As part of your initial business planning, we believe it is critical that you establish a Shareholders Agreement. This is easy enough to do, as long as you can agree, but it is often overlooked during the business planning process. Without an agreed-upon strategy how will you handle certain unforeseen events? If you have a serious disagreement, what mechanism do you have in place to resolve it? What happens if your business partner dies? What happens to their shares? These are important questions to address in the early stages of planning your business. It is easiest to come to a consensus when all the partners have the same interest in mind; to grow a successful business, not when major conflict has already arisen.

In our experience at HHMC we have encountered many situations when there have been quite significant disputes between Directors of recruitment businesses. We are often asked to facilitate an agreement between the directors and help establish a way forward for the business. This has sometimes meant the departure, on agreed terms, of one or more shareholders.

The stresses that surround owning and running your own business can create tensions between business partners, particularly when people make different choices about the directions they want to take the business. Personal circumstances and life interests may vary considerably between people over time, so it is vital to negotiate all of the terms while you all have similar objectives. This could prevent major issues from arising further down the road, and it allows everyone to clearly understand and sign off on the rules moving forward.

Related: Why you need a Shareholders' Agreement

These rules and terms are set out in the Shareholders Agreement and should specifically prescribe the means for resolving disputes and the mechanism for acquiring the shares of a shareholder who wants to exit the business. Again it is important to think of the potential events that may arise. Circumstances do change and can lead to undesirable consequences.

In our regular interaction with the industry we have seen situations where unexpected events such as personal bankruptcy, divorce, and the sudden death of a business partner have severely disrupted the business in the absence of a Shareholders Agreement.

It is worth considering what can happen in these circumstances. What effect might it have on your business if for example the spouse of your former business partner either inherits a large portion of shares or is entitled to them from a divorce settlement. This person may have had no prior involvement in the business and now might have substantial influence. Do you have the right to buy those shares in any of these cases?

Without a Shareholders Agreement in place up front, questions like this cannot be readily answered and you run the risk of having unanticipated future circumstances.

There is a well publicised trend for pre-nuptial agreements. It is worth thinking of a Shareholders Agreement as a prenuptial agreement between you and your business partners. You don't expect to have the partnership break up, but you just never know what can happen in the future.

Apart from the drastic life events discussed sometimes people just become tired of the demands of running a recruitment business and want to exit. This is not unreasonable. However, you may not be ready for this at the same time and don't want to sell. If there is no mechanism or formula already agreed for buying their shares then you are liable to have a running argument over the contribution of that shareholder, the value of their part of the business and suffer the distraction that causes. It can be difficult to shield the staff from the fallout in these situations.

It may be that one party decides for various reasons that they would like to own all of the business and wants to acquire the other party's shares. If there is an effective Shareholders Agreement then at least there is a pathway and means for an equity transaction to be completed.

What should be in a Shareholders Agreement

As mentioned, a Shareholders Agreement can be quite a simple document. It should contain enough information to ensure all shareholders are treated equitably and with respect. It certainly should prescribe a mechanism to resolve disputes. It should also include the means for the buying and selling of shares and also, importantly, a method of valuation of the shares. While this valuation method may be expressed as a multiple of revenue, gross or net profit the important issue is that it is an agreed mechanism that all parties have constructed and agree on. That, of course can be a challenge but one that is better tackled early on than when things go sour.

It is worth noting that in these circumstances the internal valuation isn't necessarily the same that would apply to an external sale. The true value of any business is simply the amount someone is willing to pay for it.

Article Written By Richard Hayward of HHMC

Categories: M&A

Tags: Strategy, Acquire, HHMC, Recruitment, Staffing, Shareholder, Buy and Sell Business, Business Valuation, advisory services

Picture of Richard Hayward

Richard Hayward

Richard has 35 years of experience with outsourcing, recruitment and advisory firms. His record of achievement includes national recruitment management roles, and executive search and selection across the ICT, banking & finance and sales & market sectors. Since 2003 Richard has been a principal of HHMC, guiding recruitment agencies through acquisition and exit assignments. Located in Sydney, Richard works with private and public recruitment agencies globally. HHMC’s innovative business strategies and well-grounded guidance result in clients realising their personal and corporate goals.

P: +61 2 9221 8285 M: +61 411 488 544

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