Going into business can be an exciting time, especially when that is shared with a trusted colleague, friend or family member. Business partnerships can be fantastic, enabling the workload to be shared, ideas to be supercharged and contacts to be leveraged, but partnerships aren’t without pitfalls. Most issues at ownership level stem from the absence of having a shareholder agreement in place from the beginning.
Here, we unpack some things to be aware of when planning to go into business with someone.
What are the different types of agreement?
How agreements are set up depends on how the business is structured. Shareholder agreements are for companies and partnership agreements are for partnership structures. If the business is structured through a unit trust then there is what’s known as a unit holders agreement, and in the case of a partnership of discretionary trust there would also be a partnership agreement.
As an overall term we refer to them as management agreements.
What is covered in a management agreement?
One of the things an agreement covers is how market value is determined if someone leaves the business and there is ‘buyout’ situation.
The market value can be determined in a number of different ways. It might be a multiple of earnings before interest, taxes, depreciation and amortization (EBITDA), it might be the value of the assets plus EBITDA, or accountant determined, or the parties can have an agreed value.
The management agreement also sets out the profit distribution and frequency, for example whether profits are withdrawn from the business monthly, quarterly or annually.
The agreement can also determine the wages of the directors. A situation may exist where one person is actively working in the business and one of the shareholders is a passive investor, so it’s important to work out what the person working in the business gets paid and how salaries are readjusted in terms of pay increases in future.
Lastly, and perhaps most importantly, it sets out how decisions are made. There may be three parties in a shareholders agreement and two of the parties own eighty percent. It would need to be considered whether it’s advisable that they can make all the decisions relating to the business. If there is majority control then big decisions can be made by two people that affect any minority shareholders.
There are different various types of decisions involved. For example:
1. the day to day management of the business eg. employees salaries, recruitment
2. more substantial decisions such as entering into supplier agreements where there might be a monetary limit stipulated
3. very important decisions, for instance if the business was to be sold or another business purchased
A shareholder agreement covers these three types of decisions, including guidelines as to which decisions must be made by all parties, which decisions require seventy five percent of the shareholders in agreement, and which decisions are the day to day decisions.
Another point to ascertain is when other parties can become directors. The situation is fairly straightforward if there are only two directors, however if there is a shareholders agreement with multiple parties, should there be an option for junior staff to become directors at a specific point in time?
When should you set up a management agreement?
We always recommend seeking advice on when to have an agreement in place. Normally it’s best practice to have agreements in place at the commencement of the business so as to clarify every party’s expectations. Depending on the amount of money involved it may be advisable to wait a short while before commencing the legal process. For example, in a start up business where costs are a major factor, there might not be the option to get the agreement in place straight away, unless there is an expectation that the business will spend a lot of money from the outset and that might make the management agreement more of a priority.
Dennis Danaher from Danaher Moulton, a Melbourne law firm specialising in commercial law states property and litigation matters, explains:
‘If there’s not a huge amount of money at risk then you might be able to get away with not having a partnership agreement. If within twelve months of operating you can see that the business is going to work and the relationship is going to work, it would be advisable to get at least a partnership agreement or a management agreement. It helps the parties understand what the expectations are of each of the parties. People have totally different expectations as to who’s going to do what and that’s where the issues generally arise.’
Often these conversations have already taken place during the normal course of events. Dennis continues:
‘If you spend at the start of your arrangement, it can certainly save a significant amount of money in future, because if you don’t have an agreement and end up getting lawyers involved, the initial two or three thousand dollar outlay is going to sound like pittance compared to the amount of money you are going to spend, plus the amount of stress involved and time wasted.’
Often when you see a lawyer they will actually make the process easier for you by asking the right questions and guiding the necessary conversations.
What happens when someone wants to leave the partnership agreement?
There’s generally a clause called an option clause in the agreement that determines if one of the partners wishes to leave then the other partners have the right to buy that person’s share.
The departing party may wish to retain access to their clients, free of any restrictions. However, a restraint of trade clause will often accompany a buyout whereby the departing party is prevented from going into a similar business with the same clients for a set period.
In the event one of the business partners engages in criminal activity, the individual could be classed as a ‘bad leaver’ and that would trigger a buyout. A bad leaver provision might also cover if the person lost their licence to operate in a professional role, for example a lawyer or accountant, and that may also initiate the buyout process. These types of situations are worth covering in any discussions with lawyers during the set up phase to decide what’s right for the business.
What are the key benefits to having a management agreement?
One of the one of the key benefits of a shareholders agreement is it changes the leveraging to resolve a dispute. Disputes can still take place, however the agreement provides the structure and leveraging to be negotiated, which can mean that disputes can be resolved a lot quicker.
Making sure your core values and vision for the business aligns, before you enter into a partnership with someone gives your business a great head start. Having those conversations early in the piece and putting a shareholders agreement in place will often avoid those larger problems down the line.
If you would like assistance in setting up an agreement, or would just like more information about this topic, fill in the below questionnaire and we will be in contact shortly!