We are very keen to help you get a reliable well-drafted agreement in place to govern your joint ventures (or “JV”). If you read this article you will understand how a good contract is essential to protect your interests whenever you are in joint ventures. Other common terms for joint venture agreements are:
- JV agreement; and
- shareholders agreement.
What could go wrong if we have no written joint venture agreement?
From the writer’s experience as a commercial solicitor, advising on sorting things out when they have gone wrong and setting up many joint ventures so that they do not go wrong, we’ve brought you 3 true-to-life examples of what can go seriously wrong if you have either no agreement or a badly-drafted agreement, or let matters get out of control. (We’ve anonymised them to protect client confidentiality.)
Case study 1: The Out-of-Control Shareholders’ Dispute
A journalist set up a media company and over the course of a few years, as the company expanded and new partners were brought in, shares were issued to them. The founder rewarded certain suppliers with shares (not so they would waive or reduce their normal charges). In this case there was a shareholders agreement, but it was inadequate.
Over time, the founder allowed his holding to be watered down to less than a majority. With one loyal partner, their combined holding was around 40%. There was then a falling out, partly caused by a divorce. The founder’s ex-wife’s brother and father each had shares in the company. The ex-brother-in-law was embezzling money by falsifying expenses claims (over £100,000). This was made more difficult to stop as the Police agreed it was fraud but did not have the time or resources to pursue it. Unusually, the ex-father-in-law was the only director who was on the bank mandate: he just kept approving the expenses payments to his son, making matters worse.
Trying to get help
The bank (NatWest) did not assist, even when they were told there was a shareholders’ dispute and were asked to freeze the account to prevent further fraud by the ex-brother-in-law and revoke the bank mandate (so that all payments out of the company’s bank account would have to be approved by all shareholders). The bank has a discretion to do this in such situations, but refused in this case, which was hugely unhelpful. The founder decided it was high time that he regained his majority shareholding, but how could he do this?
The bank and Police letting the founder down, meant he had a tough journey ahead to sort this out. The founder asked the other shareholders if they would rally round the founder, so that he could form a coalition holding over 50% of the shares, which would enable him to remove the ex-brother-in-law and ex-father-in-law as directors. However, all refused, other than his loyal friend.
How he got the company back
The ex-brother-in-law did not realise that the Police were not looking to prosecute him, so after much negotiation, he and his father eventually agreed to sell their shares to the founder, in return for the founder not pursuing matters with the Police. So they valued the company, the founder paid them for their shares and they resigned as directors. The founder had regained his majority shareholding, but the journey had been long, costly and stressful.
This shows that you need to be cautious in (a) who you give shares to, especially if issuing shares will reduce your holding to less than a majority, (b) ensure all directors are on the bank mandate, and (c) you must not expect much help from either the bank or the Police. Don’t give any shares to suppliers unless there’s a really good reason to do so.
One silver lining was that, in valuing the company and their shares, the ex-brother-in-law and ex-father-in-law forgot to take into account the value of a significant amount of surplus cash the company had at the bank, so the founder did make a small profit by regaining control over this. It helped finance buying out their shares. A second bit of luck was that a supplier the founder had given shares to (one which had refused to help the founder out in his hour of need) went bust. The founder was able to buy its shares back from HM Treasury for a very small sum.
Case study 2: From Majority to Minority
In this example, a mistake was made by the majority shareholder that proved to be costly. The main shareholder held just over 50% of the shares. Several other shareholders owned the remaining shares. The majority shareholder was a director and so too were several of the other shareholders. There was no shareholders’ agreement in place. A long-standing employee was due to retire and someone suggested a reward of a few shares as a “thank you” gift for their service. The majority shareholder agreed to this, not having taken any legal advice. He did not realise at the time the effect this would later have.
The effect of issuing these extra shares was that the majority shareholder’s holding was watered down, from just over 50% to just under 50%. The small shareholding given to the retired employee had virtually no value and was locked in, in the sense that unless someone else wanted to buy the shares, their value could not be realised.
Time passed and the main shareholder decided to retire. He handed in his resignation and asked the other shareholders to buy out his shares. The company was worth £2 million, so he was expecting to receive around £1 million for this shares. The other directors accepted his resignation and reported to Companies House that he had ceased to be a director. They said they did not want to buy his shares, but that they might if he gave a large discount.
Resolving the problem
While as a lawyer the author was able to get him reinstated as a director immediately (by arguing that he had only resigned as an employee and not as a director, as thankfully he had not specified this in his resignation letter) and then negotiate a higher price for his shares, he did not get close to the £1 million he could have had. By allowing his holding to be watered down by the issue of new shares, he had lost a huge amount of value. He got paid less than half what he would originally have expected.
(Those wondering about it may like to know that the main shareholder could not simply buy out the retired employee’s small shareholding without the approval of the other directors to the transfer of those shares, so he was not in a position to regain his majority holding and the value he had lost. The other shareholders would probably have claimed an implied right to buy a proportion of those shares. Either way, this would probably not have worked out as hoped.)
Case study 3: Death of a Shareholder
In this example, there were 2 shareholders, each holding 50% of the shares and each being a director. One shareholder died, and there was no life insurance in place to enable to other to buy him out easily. (For more about the benefit of cross-life insurance policies in this situation, read our blog article on this.) The widow, who had no experience or skills to run the company, asked the other shareholder to buy the deceased’s shares. The widow had no right to appoint a director, even if she had had the skills to help run the company.
The other shareholder said he did not have the spare funds to buy the shares. The company also did not have a large amount of surplus cash at the time. So he offered the widow about 10% of the value of the company. This was not the 50% that the widow was expecting. There was certainly no obligation on him to make the purchase and no valuation mechanism was in place. The widow could not realistically sell to anyone else, as no-one would want to buy half a private company (particularly with no shareholders agreement and no right to appoint a director). In desperation and with no other real options, she sold the shares for a fraction of what her half of the company should have been worth.
A joint venture agreement would have avoided this heartache and ensured the widow got a fair price for the shares.
How to set up Joint Ventures
So now knowing some of the pitfalls to avoid, how do you set up joint ventures correctly? We have produced a separate guide on what joint ventures are and how to set joint ventures up (it contains a checklist of the sorts of issues you need to tackle) – for more information, read our blog post here.
You can structure joint ventures as something other than a limited company, such as a partnership or a consortium. However, by far and away the most common structure is as a limited company. The remainder of this article assumes you are using such a structure. As such, the terms “shareholders agreement” and “joint venture agreement” in this context are interchangeable.
Your top Questions answered about joint ventures and shareholders’ agreements
If you’re unsure about what the purpose of a shareholders agreement is, whether you need one, or what it should contain, then this section is for you. Here we answer the top 6 questions from the Internet on shareholders agreements.
1. What is a shareholders agreement?
A shareholders agreement is a contract between (ideally) all of the shareholders of a company. It supplements the Articles of Association, which are often very basic (for example the Model Articles under the Companies Act 2006 or the “Table A” Articles from the Companies Act 1985). The standard Articles most companies adopt when you form them usually do not adequately (or at all) address:
- the fair valuation of shares;
- how a shareholder can retire and sell his shares;
- how to resolve shareholders’ disputes;
- providing adequate protections for minority shareholder interests; and
- resolving deadlocks in companies owned 50/50 by 2 shareholders.
In a company with 2 or more shareholders, missing these essential items will at some point land you in trouble. Unmodified, both the Model Articles and the Table A articles are only suitable for a company having only one shareholder. Sadly, these are usually the Articles most private companies have. They would be just as adopted in their standard form when the company was formed. Most such companies have no appropriate modifications to their Articles and no shareholders agreement.
A good agreement will fix this and make life much simpler.
If (a) you have more than 1 shareholder in your company and (b) you do not have customised Articles of Association that already deal with the essential things that a shareholders agreement covers (see “What is a shareholders agreement?” above), then the answer is always, “Yes, you need a shareholders agreement”. For more on this see, “Why have a shareholders agreement?” below.
The shareholders or joint venture agreement covers 3 distinct phases in the operation of your joint ventures:
- Setting up the new JV: the parties’ respective obligations in setting up the joint venture. For example, what each will do and why their participation is valuable;
- Running the JV: how the joint venture will operate, voting rights, etc; and
- The “exit”: this covers what will happen if the parties fall out or one wants to leave.
Each of these is essential.
3. Why have a shareholders agreement?
If you have identified that you need a shareholders agreement, then you might want to know why you do.
Your company’s Articles are usually totally inadequate for the needs of a company with more than one shareholder. For example, without a mechanism to resolve disputes and value shares:
- you could deadlock the company in a stalemate; and
- a shareholder who wants to leave and sell his shares may find that the other shareholder is reluctant to buy them out or to pay a fair price for the shares.
What could happen if you don’t?
Worst still, if a shareholder dies, the surviving spouse may:
- have no right to be a director;
- have no access to the accounts of the company, and
- want to sell the shares but have no power to force the other shareholder(s) to buy them.
In desperation to sell, she may end up selling for far less than their true value. This is just like one of the examples above.
A shareholders agreement can fix all this, protect the value of your shareholding and provide for your loved ones.
A contract for the shareholders also deals with disputes between shareholders. The dispute resolution mechanisms the contract contains mean they head off a shareholders’ dispute before it develops into a problem. A good contract between the shareholders will:
- avoid a legal dispute escalating;
- save thousands of pounds in legal fees;
- avoid wasting management time; and
- thus you avoid heartache and stress.
To read more, see our blog post on “5 Reasons Why Your Business Needs A Shareholders’ Agreement”. You will find that article a very helpful and detailed explanation of the subject.
4. How to draft a shareholders agreement
While you can use a firm of solicitors who specialise in company law matters, it will be an expensive exercise. Instead, equipped with the right tools, you can do this yourself. You can save a considerable sum at the same time.
Legalo has made this simple for you. You don’t need to start from a blank sheet of paper. We have a template shareholders agreement that you can use for £44.95. It does all the hard work for you.
5. What should a shareholders agreement contain?
We have a separate blog post on this topic. See our blog post “Four Clauses That Should Be In Any Shareholders’ Agreement” for the key clauses that such an agreement needs. Legalo’s template already covers all of the key topics. To see all of the topics our template covers, click on the link to the guide to the shareholders agreement template.
6. Do all shareholders have to sign a shareholders agreement?
To be bound by the agreement, a shareholder needs to:
- be a party to it and sign it, or
- sign a “deed of adherence” to say that he agrees to be treated as a party to an existing shareholders agreement and to abide by its terms.
The latter is often used where a new shareholder joins the company after the original shareholders agreement has been adopted.
Ideally, every shareholder would sign the agreement. Then they are all subject to the same rules, and the share transfer and disputes resolution mechanisms cover everyone. It can still be of some benefit if a significant majority sign it, even if not everyone is willing to. If not everyone signs it, then you would need the Articles of Association of the company to contain the provisions about valuing and transferring shares, so that all shareholders are bound by them.
Take action to protect the value of your shareholding
So now we’ve convinced you of why you need a joint venture or shareholders’ contract, what are you waiting for? Take action to protect your shareholding now by downloading our template shareholders agreement.
If you have other questions, we’re here to help – just contact us.