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Business Owners: Please Do Not Forget The Shareholders Agreement

By 13th February 2024Corporate & Commercial
Shareholders Agreement

The horrific stories that have come to my attention from the founders of new and established businesses quite frankly boggle the imagination. These are stories from business founders who have had brilliant ideas and started their businesses but have been left penniless and in certain instances destitute, once they had established their businesses.

All of us understand that starting your own business can be an extremely costly affair. For many founders, getting to the point of actually deciding to open their own business can often be the result of numerous and difficult personal, family and financial decisions.

Opening your own business can be the result of any of the following factors:

  • a decision to leave the safety and security of salaried employ;
  • a decision to take early retirement from your place of employment;
  • retrenchment by an employer;
  • termination of employment by an employer; or
  • dissatisfaction with prospects, growth or salary at a former place of employment; or financial demands that require a greater income.

Once an individual, has made the tough decision to establish his/her own business and decided to “open his/her own company”, the first step that instinctively follows is to purchase, usually at the cheapest possible price an “off-the-shelf” company. Once the purchase has been made and confirmed, most retailers of shelf companies will at an additional cost take care of the following formalities:

  • change of shareholders;
  • change of directors;
  • appointment of new accountants;
  • change in registered address; and
  • issue of a new share certificate.

It would be incorrect for the founder, now a shareholder and director (on his/her own or with others), to think that all formalities have been complied with and that he can now start running the business. The aforementioned is only the start of several administrative formalities that must be completed for any business to successfully operate within the current South African legislative environment. The situation also becomes more challenging when there is more than one shareholder and/or more than one director.

Often neglected or at least left for the last moment are some of the following:

  • opening of bank accounts and the formalities related thereto;
  • Depending on the nature of the business there may be business sector requirements;
  • statutory registrations at SARS for income tax, PAYE, SDL and VAT;
  • if the business is to have employees, several associated formalities need to be complied with; and
  • statutory compliance reporting and manuals related to health and safety and public access to information.

All of the aforementioned involve considerable time and expenses. Hopefully, the founder has, before deciding to open his/her own business, put together a solid business plan and determined the financing and funding requirements of the business. The business plan should set out how the business is going to be managed (and by whom) and also provide details of all the employees required, job descriptions and salaries.

In most instances, the decision to open a new business usually involves more than one person. Often, but not always, different people come together deciding to open a business bringing with them different skill sets and often significantly different financial abilities and requirements.

The success of many businesses established by multiple founders is directly related to their ability to work together and function as a team, with a complete understanding of their respective responsibilities and the boundaries of those responsibilities. In many instances new businesses are started by friends or family or both, when one of the founders with a certain level of skill and experience recognises a potential business opportunity in the market but requires support, often this being financial support.

In my experience, one of the biggest mistakes made by founders is the failure to pay proper attention to how equity in the business is allocated amongst themselves and the basis therefore. A further mistake made by founders is a failure to properly value the equity in the financing of the business and the skills required to ensure the business is successful. It is not surprising that in many instances, the moment the newly formed business experiences some hurdle or challenge, it is the founder who has provided the financing that is the first to pull the plug on the business while the founders who bring the skill and expertise, and who are familiar with business and market conditions, are the ones left without any ability to control the business.

Many businesses that currently operate, do so at their peril as they fail to put in place properly drafted and constructed shareholder agreements tailor-made to the specifics of that business and shareholder environment. Putting in place a shareholders agreement is often a neglected exercise because of the costs involved and often requires numerous drafts and many hours of meetings at a time when most of the involved parties are simply focused on operational rather than administrative matters.

I would like to encourage all the founders of current and future businesses who have decided that a company is the way they will give effect to their business ideas to first consider, when more than one shareholder is contemplated, putting in place a properly drafted and constructed shareholders agreement even before the “off-the-shelf” company is purchased.

Some of the matters addressed in shareholders agreement are as follows:

  • name of the business;
  • shareholders and directors and their replacement and removal;
  • shareholding held or allocated and the nature and class of shares;
  • requirements for shareholder and management meetings;
  • transfer of shares, pre-emptive rights and restrictions thereon especially if the company has a B-BBEE rating;
  • voting and voting percentages required;
  • matters that are reserved that require approval levels greater than a simple majority;
  • company secretary, public officer, management and administrative matters;
  • business plan (including the funding approval and amendment thereof);
  • opening bank accounts;
  • funding of the business through equity, shareholder loans; bank loans
  • repayment of loans and dividend policy;
  • reporting responsibilities;
  • delegation of powers and authority for purchasing;
  • termination;
  • disproportionate loan funding amongst shareholders;
  • effective dispute resolution mechanisms;
  • liabilities and indemnities;
  • policy for the appointment of employees (especially in a family business); and
  • policy regarding the procurement of goods and services.

There is however one intangible benefit that I have discovered in first putting a shareholders agreement in place that surpasses all those benefits listed aforesaid. Let me explain, part of the process of putting together a properly drafted and constructed shareholders agreement is that the shareholders need to work together in the scenario planning that takes place with all parties present. The parties will then determine what the consequences are for the shareholders, directors, management and finally the business itself in those scenario planning exercises. Scenarios can be both positive and negative. This process often helps the parties determine the true level of commitment of each person to the business and whether there is sufficient trust amongst the founders to establish a functional team and ensure the success of the business going forward. These scenario planning exercises and responses often result in the falling away of persons not truly committed to the business, but also reaffirm and strengthen a person’s commitment to each other and the business.

Please do not hesitate to contact us and we will assist in making sure your business and future are based on a solid foundation with properly drafted and constructed shareholder agreements.

 

Barrisford Petersen
barrisford@bbplaw.attorney
Managing Director

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