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How to keep your new company intact

18 Jul 2016

The issue

Picture the scene… You’ve started your new company and things are going well. You have a regular stream of customers and the profits are pouring in. You’re growing fast. So, what happens next? You may well need capital – and this can be problematic.

Larger corporate investors will usually lend on terms – for example, taking a debenture (a type of mortgage) or a personal guarantee, or both. The scope for negotiation on their standard terms is usually limited or non-existent, so there’s not much room for manoeuvre. By and large, corporate lenders are also unlikely to be interested in the other option – taking an ownership stake in your business in the form of shares.

So, you’ll probably need to look at smaller investors or business partners. They’ll more readily want to help you, but they’ll want a share (an equity stake) in the company in return. That may suit your needs at the time, but the risk is that the new shareholder sells his or her shares to some unknown party. Worse still, if there’s a falling out, both parties will need a way to manage the exit of one or other of them.

These disputes can get pretty personal in small businesses. With an agreement in place, you can minimise the nastiness; you can’t remove it completely, but you can lessen the impact both on shareholders and on the company.

Transferability of shares

Shares are transferable only in accordance with a company’s articles of association. In usual circumstances, standard articles allow shares to be freely transferable, but in private companies, the articles can apply restrictions.

An alternative approach is for the shareholders to enter into a shareholders’ agreement, setting out transfer restrictions.

How to guard your business

What you cannot do is impose an article that prohibits absolutely any transfer of shares. But what you can do is make it a qualified bar – for example, to prevent transfer to a competitor. And you can make registration of the transfer subject to the consent of the directors or the other shareholders.

What you can also do is put in a ‘first refusal’ article. This type of article is more properly called a ‘pre-emption right’. In effect, the outgoing shareholder must first offer his or her shares to the other shareholders in proportion to their existing shareholdings. You can draft a valuation mechanism too, just in case no agreement can be reached on the price. You can even draft a clause or an article that allows someone who has had enough to force the remaining shareholders to buy him or her out.

Mechanisms

You can either amend the articles, or you can give effect to the restrictions by means of a contract – the shareholders’ agreement. The benefit of amending the articles is that it applies to all shareholders. The benefit of the shareholders’ agreement is that you need not worry about company law technicalities of amending the articles; the disadvantage is that you’ll need to get each new shareholder to sign up to it or it will have no effect on the newcomer.

Conclusion

You can protect your company and you can protect the interests of all the shareholders. And there are ways and means of managing and lessening the emotional impact of small-company shareholder disputes. With the right mechanisms in place you can focus on what you do best – running your business successfully.

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