Steve Jobs and Bill Gates had more than rivalry and business success in common; they also shared similar accounts of business failures as a direct result of partnership blunders. Many business owners identify with disagreements among shareholders relating to money, performance or meddling spouses. The result of ongoing dispute may result in breakdown in trust, loss of customers and income, and the eventual demise of a business.
Some disputes are more serious than others, and has a direct negative impact on business performance – such as refusal to sign suretyship to raise working capital finance; misalignment of strategy, vision or values; poor performance and work ethic; conflict of interest; or bad financial management. Disputes can arise for any given reason. Sometimes if satisfactorily managed or cultivated, conflict may result in creativity and innovation.
Build a strong foundation by establishing clear boundaries at the outset on duties, powers and obligations of shareholders and directors. The best way to do this is to research typical scenarios that may give rise to conflict and establish policies and legal agreements providing guidelines on how to resolve the conflicts. Here are a few ideas on how to establish policies.
1. Scenario Planning – Consider how the shareholder relationship may be impacted if the business is confronted with various negative and positive scenarios, such as rapid growth, or a working capital funding crises or financial loss. On considering the various scenarios, mitigate by establishing “how to” policies.
Examples of possible scenarios may include breach of various duties, lack of support or varying vision of the company’s strategy and management, disagreement with dividend policies, disparities between salaries, separate business interests, failure to provide financial, accounting and statutory information, exclusion from meetings and breaches of shareholders agreements.
2. Know the Law – The Companies Act 71 of 2008 (Companies Act) sets out precisely the powers and limitations of shareholders and directors. The Companies Act provides guidance on shareholder meetings, proxies or resolutions, among various other provisions. Applying the law ensures compliance, knowledge of rights and duties, and assists with preventing and resolving disputes.
3. Corporate Governance – Learn international best practice on corporate governance and adopt the King Code guidelines from the get-go. The following are few tips on how to establish simple corporate governance in a small business.
4. Document all Terms and Rules of Engagement – Documenting includes executing valid and legitimate agreements such as a user-friendly Memorandum of Incorporation (MOI) (mandatory), Shareholders Agreement (optional but recommended), Management Contracts or Letter and Terms of Appointment as Director or Memorandums of Understanding. Each of these agreements will establish the precise rules of engagement with clear boundaries on what is permitted and what is not, and more importantly how to resolve disputes as an alternate to approaching the courts.
1. Capital Contribution – Clearly state how much each shareholder has contributed, whether the capital is applied as equity or shareholders loan and terms of repayment if any. It is also necessary to determine how future shareholders loans will be applied and repaid, and any arrangements on raising capital in the future from shareholders and third parties. In some instances shareholders will be required to contribute monies, security, or sureties.
2. Minority and Majority Shareholder Perspectives – Minority shareholders look for protection in quorums to commence with meetings, vote at meetings and pass resolutions, and the right to appoint directors on the board. This will ensure complete and autonomous representation of shareholders and reduces the risk ambushing or bullying tactics by majority shareholders. In addition, minorities look for protection on disposal of shares in the Tag Along principle – if a majority is selling, the minority has the right to join the deal.
Similarly, majority shareholders look for protection in adequate board representations and quorums. Critical to majority shareholders is pro rata participation of all shareholders and that the majority is not required to carry the burden of financial or administrative support or pro rata dilution if the business issues new shares. Similar to the minority, the majority is protected during disposal of shares in the Drag Along principle – if a third party wishes to buy all the shares of the business and the majority wishes to sell, the minority is forced to sell.
3. Disposal of Shares – Disposal of shares may include sale to a third party, disposal on death or incapacity or retirement as an exit strategy. Shareholders often dread the introduction of heirs and beneficiaries to a deceased estate for multiple reasons including the lack of ability to strategically influence the business. Mechanisms in managing disposal of shares included in the Shareholders Agreement may comprise of pre-emptive rights or first option rights to remaining shareholders for voluntary and involuntary sale; or introducing a succession plan for retirement; or establishing a call put / call option to the business on retirement dates.
1. Shareholders Agreement – The Companies Act and MOI adequately cover the basics terms of engagement including powers, duties and related limitations. It is not a requirement of law to execute a Shareholders Agreement. However, it is highly recommended that shareholders conclude such an agreement.
2. Negotiation and Mediation – The first step of resolving a dispute is for parties to commit to avoiding approaching the courts. To this end, the Shareholders Agreement should clearly state that the all parties will negotiate, and if required appoint an appropriate independent third party, such as an expert in the field of the dispute, to mediate the negotiation.
3. Formal Arbitration – If the negotiation and mediation is unsuccessful the parties can approach an arbitration body such as the Arbitration Foundation of South Africa, or submit a complaint to the Companies and Intellectual Property Commission. The objective of arbitration to is to offer an alternate to resolving disputes in court. However, shareholders must consider the rules and costs of this route.
4. Litigation – The Shareholders Agreement must allow for any party to approach the courts if alternate resolution is unsuccessful or if a matter is considered urgent such as an application for an urgent interdict. As with arbitration, shareholders must consider the cost implications of this remedy.
A shareholder cannot be dismissed nor resign voluntarily or involuntarily. The only way a shareholder may exit the business is if she sells or donates or bequeaths her shares to a third party, or to the remaining shareholder or the company; alternatively if the company liquidates. It is therefore critical that 2 important aspects of preventing or resolving shareholders dispute are implemented at outset of any start-up business. 1) Take all steps to ensure that this is the right match for you and your business. 2) Be absolutely certain on when and how to exit if the arrangement does not work out.
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