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Why you need a Shareholders' Agreement


HHMC works with Recruitment companies right around Australia giving us the opportunity to see so many excellent, well run and well structured businesses. However, it also means we see those with some potentially important structural issues that have not been addressed. Many companies either do not have a Shareholders agreement in place or don't have an adequately written agreement. This doesn't mean that the business isn't performing profitably but it can mean it has the proverbial "ticking time bomb". If that sounds like an exaggeration then it is worth thinking about the consequences that can come about when directors or shareholders disagree. These often may not emerge until selling the business becomes a goal.

It is not surprising that this occurs. People starting a new business are understandably excited about the possibilities that await and the last thing they want to consider is the worst-case scenario; the failure of the business, or working relationships that break down. However, this scenario occurs all too often.

If you are planning to go into business with someone else, or have other shareholders, then it is critical that you establish a Shareholders Agreement. This is easy enough to do, as long as you can agree, but catering for potential differences of opinion and providing a mechanism to overcome them requires more work. Without an agreed-upon strategy how will you handle certain unforeseen events? If you have a disagreement, will your business partners be willing to exit the business and sell you their shares? At what price? These are important questions to address in the early stages of planning your business

In our experience we have encountered many situations when there have been major disputes between directors of recruitment businesses. Recently we encountered a situation where one minority shareholder out of several shareholders refused to sell and had the power to block the sale agreed on by everyone else. It was not a happy situation.

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 directors or 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.

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 own perhaps half. Do you have the right to buy those shares in any of these cases?

Related: Why Do Shareholders Agreement Work

Without an adequate Shareholders Agreement in place, questions like this cannot be readily answered and you run the risk of having some unanticipated new partners.

There is a well publicised trend for pre-nuptial agreements. In this case it is worth thinking of a Shareholders Agreement as a prenuptial agreement between you and your business partners. You dont 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 dont want to sell. If there is no mechanism or formula already agreed for the acquisition their shares then you are liable to have a running argument over the value of their part of the business and the consequent 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 want 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 but it should include the means by which remaining shareholders can acquire the shares of another. It should also prescribe a mechanism to resolve disputes and also, importantly, a method of valuation of the shares that has been agreed to. While this valuation method may be expressed as a multiple of revenue, gross or net profit the important or 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's worth noting that in these circumstances the internal valuation of a portion of shares won't necessarily have the same pro rate value that would apply to an external sale of all of the shares. The market value of any business is simply the amount others willing to pay for it at any one time.

The old expression "begin as you mean to end" is one that certainly needs to kept in mind when you start a business.

Originally Published in Recruitment Extra July 2011

Categories: M&A

Tags: Strategy, Acquire, HHMC, Divest, Recruitment, Shareholder, Merger and Acquisition, Buy a Business, Acquiring Recruitment Business

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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