Are Pre-Nups Becoming A Business Essential?

In business as in marriage, planning for unseen circumstances can help make potential obstacles easier to navigate for co-founders. For example, without agreeing exit routes, when shareholders or partners do decide to leave the business, things can quickly become complicated.

When a business relationship dissolves, especially between family and friends, emotions can become heightened and parties might be less willing to negotiate. Therefore, agreeing key discussion points prior to entering a business relationship is vital to maintaining an amicable split. Those who choose to proceed without a ‘pre-nup’ or Shareholder Agreement, in place risk a lengthy court process, or even losing the business altogether.

A ‘pre-nup’ or Shareholder Agreement should address how a business operates and the rights and responsibilities of those that hold shares. This includes ‘futureproofing’ against potential scenarios including, but not limited to, “good leaver” circumstances, for example when someone retires or are made redundant, and “bad leaver” circumstances, for example when someone is lawfully dismissed.

It is important to differentiate between these circumstances because a shareholder cannot be forced to sell their shares, even if they leave the company as an employee. Therefore, if someone leaves due to gross misconduct, they could feasibly continue to make profits from the business.

If a company decides to operate without a Shareholder Agreement in place, there can be severe consequences. In a recent case, a financial services company was forced to ‘wind up’ or liquidate after one shareholder lost his accreditation and therefore could not legally sell financial products or give advice.

This presents two options. The shareholder could resign as director – meaning that the business would be unable to continue to work with his clients or contacts due to a non-compete clause. Alternatively, they could wind up the company which could not only cause reputational damage but also mean that the years of hard work to set up and run a successful business would be wasted, simply because no agreed exit strategy was in place.

A Shareholder Agreement is not only to decide exit strategies, however. It is also used to outline the rewards shareholders are entitled to from a profitable business. This will help motivate the employee as they can see a direct link between their performance and the value of the business’ shares. The Shareholder Agreement can also be used to dissuade behaviour that may lead to a dismissal, as it sets out clear standards and expectations of behaviour.

In the age of the internet, many individuals feel as though they can draft their own legal documents, including Shareholder Agreements. While this may be an inexpensive option at the time, it may cost more in the long-term. Shareholder Agreements must be written with specialist terminology and address a wide range of circumstances that some business leaders may not know to consider. Therefore, it’s particularly important to seek the support of an expert to make sure that the document will be accepted in a court should the need arise.

It is also important to remember that while the Shareholder Agreement will not need updating on a regular basis, when organisational or structural changes occur, for example if new shareholders are brought on board or if shares are sold, the document must be reviewed and revised as necessary. It is important that the document does not go out of date, as then it will no longer be a valid agreement and could make the shareholders legally vulnerable if someone does wish to leave.

Shareholder Agreements or a business ‘pre-nup’ are a method of futureproofing a company and safeguarding its shareholders. By agreeing what will happen across common future scenarios, such as someone deciding to leave, it will make that exit a smoother process for everyone involved. Agreeing beforehand could also save business partners from a stressful and potentially expensive court process as well as relationship breakdown. Shareholder Agreements are therefore not just a ‘good idea’, but should be viewed as a necessity for companies who want to save themselves from a potentially sticky end.