Dealing with bad blood in your small business – Part 1

Many of the clients we encounter in our practice are small businesses, started by friends or family.  Typically, the founders will set up a proprietary company in which they are each directors and shareholders.  Usually, each person brings a different asset or skill set to the business – time, capital or expertise.  In the beginning, the business is usually worth little and no-one is conscious of or willing to talk about what could happen if the relationship sours.

The running of a business is often stressful and it is not uncommon for disputes to arise between the directors, even if the business is successful.  If such disputes are not resolved quickly, the relationship can deteriorate to the point where the company cannot function because the directors cannot agree on anything.  In the worst case scenario, this leads to the company being wound up and a large proportion of the capital being spent on lawyers’ and liquidators’ fees.

Sort it out at the start

Unsurprisingly, the best advice for dealing with a dispute between directors is to avoid it in the first place.  Before starting a business, the parties should consider and, importantly, discuss:

  • how different types of decisions about the business will be made;
  • what decisions should require agreement of all directors;
  • what happens if there are an equal number of directors and there is a deadlock;
  • what each party is expected to contribute to the business, both initially and on an ongoing basis;
  • what each party is entitled to by way of salary, leave and other benefits;
  • how, when and in what proportions profits should be distributed;
  • what information should be provided to directors and shareholders and at what intervals;
  • what should happen if one party wants to leave the business;
  • what should happen if one party dies or becomes incapacitated; and
  • how the business should be valued if one party wants to sell their shares or if a new shareholder is being brought in; and
  • whether directors should be restrained from competing with the business if they leave.

These matters should then be formalised in either the company’s constitution or a shareholders agreement.

If the shareholders do not agree on a customised constitution or shareholders agreement, the replaceable rules in the Corporations Act 2001 (Cth) will apply to the company and these rules may not produce the result the parties envisaged at the outset.

Spending the time and money to resolve these questions at the start will reduce the likelihood of a dispute arising later, or if it does arise, reduce the cost of resolving such a dispute.

Please contact Claire Carton, Partnerif you require assistance in setting up a company or preparing a shareholders agreement.

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