I frequently undertake seminars / mentoring for start-up and growing companies … they never understand why as my number one rule I tell them always to document everything. I am sure you know, but I thought you might like some examples. All come from real deals
Example A
Mr Smith owns all of the shares in a private manufacturing company. The company is doing well but Mr Smith is not getting any younger and wants to slow down. He brings into his company, where he is currently sole shareholder and sole director, Mr Jones. He sells Mr Jones 25% of his shareholding for £25,000 and it is agreed that should Mr Jones leave he will resell the shares to Mr Smith. Five years later the company has expanded dramatically and is making very large amounts of money. It has trebled its workforce and can barely keep up with its orders. However, Mr Smith and Mr Jones are unable to carry on working together and Mr Jones wants out. Mr Smith says that’s fine and he will buy the shares back from Mr Jones for the same price at which Mr Jones acquired them, i.e. £25,000. Mr Jones is not a happy man! He suggests that the price for the shares should reflect the massive rise in the company’s profitability over the last few years and requests a figure some twenty times the amount offered. There is no documentation to assist.
A simple agreement (even if covering little else) might have included words to the effect that “should Mr Jones leave, his shares will be valued by an independent third party (which may include the company’s auditors), and such valuation will be the price at which Mr Smith will purchase those shares”. Of course, the clause could have been slightly (or much) longer but even basic wording such as that ought to have done the trick. In the end – and this is based on a set of facts almost identical to the example given – the parties agreed a very expensive deal for Mr Smith on the steps of the court. As I recall the total bill, including the cost to re-buy the shares and legal fees for both parties, was in the region of £750,000. The initial price that Mr Jones paid for the shares was about £4,000.
Example B
Mr Blue and Mr Grey each own 50% of the shares in a private limited company. They are the only directors and shareholders. There is no shareholders’ agreement or any other written arrangements between them, they decide they don’t want to “waste their money”. After some time working together, they disagree entirely about the future direction of the company and there is a complete breakdown in trust and confidence between the two of them. The company is profitable and has plenty of cash in the bank. Neither of them is prepared to sell his shares to the other and neither of them is prepared to sell his shares to a third party. Each wants total control of the business.
There are legal mechanisms by which they could deal with this but that would involve an application to the High Court. Neither is prepared to pay to initiate such proceedings. Because of the mistrust between the parties the bank accounts are frozen. The company, therefore, cannot pay its debts even though there is plenty of cash “available”. In the end after several weeks of fruitless negotiations between them, they get some sensible and commercial advice from their respective lawyers, and they come to a settlement – although not necessarily the best one. It does not really matter what that settlement is.
During the interim period the customer base of the company has suffered badly. The company lost the confidence of its employees and its suppliers. There is a sense of mistrust between the two parties on an on-going basis and six months later the company is sold for a significant discount to its true value. Both shareholders end up with a lot less than they would have wanted.
Example C
Mr James and Mr Jones each own 50% of a PR company. They disagree on the future direction of the company. It is all very friendly but they don’t want to continue working together. The company is extremely successful and has a very large pot of money in the bank. They are both equally relaxed as to whether they go or stay but one of them will have to go – the other person will continue to operate and, indeed, own the company. The fact that there is a significant cash sum in the bank again, there is no shareholders” agreement or any other document which plots a route to determine how they divide up the company. In this instance a truly “commercial” solution was suggested.
The fact that they were media related companies inspired their legal adviser to suggest they invited their friends and contacts, together with as many media sources as they could find. They would toss a coin. The person who chose correctly would then decide whether he took the cash or the company – in this case, remarkably, both were sufficient to satisfy each party. Unfortunately, although one of the two shareholders thought this was a great idea – the other didn’t. The outcome is not known but rumour is, again, they ended up in court.
The fact there was no shareholders’ agreement added significantly to this drama. A good lawyer advising clients setting up a business together would always suggest some sort of written document between them. It could be as long or as short as they wish. None of this is particularly difficult or particularly expensive. The cost of litigation is significantly greater in time, cost and management terms, than the cost of having a short, clear shareholders’ agreement drawn up at the outset. That said, the number of times people just don’t , won’t bother never ceases to amaze me.
Example D
X and Y are close friends—and sophisticated buyers of legal services and have, in the past, spent millions on legal fees. X agrees to lend Y about US$16 million. X uses legal advisors, but this time, Y doesn’t. Alas, 15 months later, Y had spent about US$1.5million on trying to get himself where he should have been at the start. He had also part paid down the loan as to about 30 per cent. The legal fees for this one were probably in excess of US$10 million.
It is fine to have a right (whether or not set out in your documents) but to bring a claim, win in court and then get what you wanted at the start is really very expensive and time consuming. To some people, UK law looks easy… that is until you start reading the actual words and try and use them to sort out your possible dispute. The same applies to the words in the contracts we all try so carefully to draft and then interpret; thankfully at least in 99 % of cases, the matter never reaches court; but what if it does? It is easy enough to put in the word “and“ instead of the word “or “; or to miss out the word “not “, never mind the complicated stuff.
Third article by Nick Gould on contracts and deals.
