The growth of social media giant Facebook reads like a fairy-tale. Born in the dormitory of Harvard University student Mark Zuckerberg, the social network now boasts 2.2 billion monthly users1.
The rise was so dramatic that it even led to a 2010 movie The Social Network. The film was particularly interesting as it explored the breakdown in the relationship between Zuckerberg and co-founder Eduardo Saverin.
Zuckerberg felt Saverin was not pulling his weight at the company and he and fellow shareholders manoeuvred to dilute Saverin’s stake and fire him. Legal action followed.
This tale has ramifications for all start-ups, particularly those who set up with friends. They may feel optimistic about the future and the strength of their working and personal bond, but relationships can darken and disputes take hold.
One way of preventing a catastrophic fall-out is to set up a shareholders agreement. It regulates the relationship between the company and some or all of its shareholders. It fleshes out issues such as share transfers, share allotments and shareholders’ personal obligations and rights.
“Time and time again people set up companies with their best friends and they think they will remain so all their life. They don’t see the need for formal arrangements,” says Paul Taylor, partner at Fox Williams. “That friendship might be OK over a few beers, but it has never been tested in the hot-house climate of a start-up. You might be working all the time but your fellow owner might not be beavering away so much or decide they want to change career. Have the ‘What if’ conversation now.”
On the subject of leavers, Taylor says a shareholder agreement should include information on phased vesting, identifying when departing employees can retain their shares or when they are deemed to have offered them for sale to the company or other shareholders. Regarding the price the shares are sold for, a distinction needs to be made between good leavers ‘who perhaps leave to farm goats in the Outer Hebrides’ and who will receive market value price, and bad leavers who go to competitors or go because of misconduct and who receive a lower price.
Restrictions and deadlocks
Matt Cunningham, partner at Waterfront Solicitors, says restrictive covenants can be placed in the agreement, such as non-compete clauses. Covenants can also include obtaining the consent of some or all of the shareholders before new shares are issued and new directors appointed.
When it comes to disputes, deadlock resolution provisions can be put in. “You may have two owners, both with 50%, and they can’t move forward if they have a disagreement,” Cunningham explains. “Provisions could mean that you move to non-binding mediation or provide a nuclear mechanism for the compulsory purchase by one party of the other’s shares.”
Some of these provisions can be enshrined in the company’s Articles of Association, which are binding on all shareholders. They can also contain rules on the number of shareholders, their duties and interests, and company procedures.
However, as they are a public document filed at Companies House some issues such as exit strategies, dividends policy and incentivisation schemes should be kept in the private shareholders agreement.
“There are no hard and fast rules regarding what should go in where. There is lot of flexibility but the important thing is that this discussion happens,” Cunningham says. “It is quicker and cheaper to deal with it now than solve it later on.”
Doing it later
Ed Brown, who founded healthy fast food restaurant Friska in Bristol in 2009 with friend Griff Holland, says there can be a different way.
“Before we set up we had a meeting with our solicitor about a shareholders agreement,” he recalls. “They said you can do it but it may be wiser to spend your money on getting up and running. After we were more established we should look at doing it.”
It took four years for Ed and Griff to get a shareholder agreement signed. “We had grown to a more tangible size, created value and had our eye on investment so we wanted to get the structure in place,” he says. “We had the discussion of what we felt comfortable with if one of us dies or decided to leave. It wasn’t that emotional, we just didn’t want the business to be put at risk.”
1zephoria.com/top-15-valuable-facebook-statistics, June 2018
Your St. James’s Place Partner will be able to advise you on which of our panel providers you would need to be referred to given your particular circumstances for further advice in this area.
Please note that advice relating to Shareholder Agreements will not be regulated by the Financial Conduct Authority or the Prudential Regulation Authority.