What happens when happy partnerships turn sour?
The latest trend in TV reality shows seems focused on putting budding business leaders through their paces in a bid to prove that their particular undertaking will provide a route to riches. From Make me a Million to The Apprentice and Dragons’ Den, eager entrepreneurs pitch for the support of a business guru to offer advice and help or a cash injection from investors keen to take a share of potential future profits. Whilst no-one wants to contemplate the possible failure of an enterprise they believe wholeheartedly will succeed, the harsh truth is that the odds are stacked against the optimists - with or without the backing of TV. Yet few start-ups even consider putting in place procedures to deal with the dissolution, or change of their business if things should go wrong. John McBride, Location Director of Vantis McBrides, Sidcup, looks at the causes of ‘bust-ups’ in the boardrooms - and how they can be handled.
Anticipating antagonism
Perhaps unsurprisingly, business ideas are often borne of close relationships. Two colleagues, disillusioned with the management in their present positions, decide to go it alone; a brother and sister both keen to continue the family firm agree to divide the responsibility; a husband and wife with an image of cosy coupledom turn a hobby into a commercial concern. But it’s this very closeness that makes discussion of the unthinkable – “What happens if things go wrong” - hard to broach. As a result, agreements to cover the possibility of one or more partners electing to bail out of the business tend to be informal and undocumented - fine when things are going well - but disastrous when they’re not!
Companies in their start up phase are more often than not strapped for cash - so any additional expense that’s not deemed absolutely vital to survival is usually avoided. So even if a business adviser, at the start-up stage, recommends having a shareholders’ or partnership agreement drafted by a lawyer, it’s likely to be rejected.
Understanding the main reasons for fall-out at board level may help business leaders avoid some of the pitfalls and should certainly bring home the very real issues associated with maintaining the status quo within the business.
The causes of conflict
Disagreements among shareholders can be fuelled by a number of factors as illustrated below.
- Keeping it in the family
The happy couple that thought working together would bring them even closer together discover that a 24/7 relationship with the added stress of a business to run is far from an easy ride. Or the siblings keen to keep the firm in the family find they have very different ideas about how that business should be managed. Be warned: a good relationship outside the office doesn’t necessarily translate into best practice in the boardroom.
- Imbalance of activity
Whether only one of the shareholders is successful at bringing in new business which benefits everyone, or another has contributed a greater share of financial backing, the balance of power within a company is delicate. It may have been a talent in a particular aspect of business or availability of equity that prompted the set up in the first place - but it can also be the root of resentment in later stages. Personal circumstances can also change. Someone happy to dedicate 60 hours a week to the business may need to cut back dramatically if they suddenly have a sick relative to care for.
- Inequality of power
Most businesses begin with a not unreasonable expectation that all participants are equally keen to contribute to the business. But like George Orwell’s Big Brother, it’s too often the case that some are more equal than others…or rather more powerful than others! When a natural leader emerges, this can leave others feeling demotivated and impotent - with the result that they elect to leave the business. What many fail to check before they elect to leave the company is the value of their shareholding, which may not be what they expect. Shares (in the absence of any agreement to the contrary) are generally valued not simply according to their face value, but according to the voting power they have; so owning ten per cent of the shares in a company means that the holder has little control - and the shares could be worth less than 30 per cent of their expectations.
- Disagreement on direction
As any couple that’s shared time in a car knows, navigation is a common cause of arguments! Directing a business is map reading on a bigger scale, with the business leaders setting out where they want to go and the best route to get there. While business partners may agree initially on how the business should develop, conflict can arise if one has a subsequent change of heart and wants to steer the company in an opposing direction.
- Reaching a certain age
Unpalatable though it is, we do slow down as the birthdays tick by. An energetic twenty-something embarking on a business venture with a partner ten years older could later find that he’s saddled with an old ally who now lacks dynamism as he winds down to a retirement free from the worries of business life. But where does that leave the business in terms of moving forward and keeping pace with new trends?
- Running the risk
The one sure thing in business is that every decision is a risk. If one participant is happier to accept risk than the others, there will be a fundamental impact on how the business is run. And the more risk-ready leaders will be frustrated and alienate the others, who feel more comfortable steering a conservative course.
Routes to resolution
So what routes can businesses take to deal with a bust-up in the boardroom? There are a number of options open depending on how the entity has been set up in the first place and the severity of the split. Key is making sure there is a clearly defined agreement in place (via the Articles of Association and a shareholders’ or partnership agreement) to tackle every conceivable eventuality so that an amicable and financially efficient solution can be reached.
So what sort of steps can be taken in the given circumstances of dispute?
- Selling up
Putting the business up for sale frees the dissenting parties to go their own way and should realise true value. It is generally a last resort, especially as a purchaser may require the ongoing services of the participants. The equity share invested in the company will usually influence the proportion of the share of the sale price they receive. Restrictive covenants may come into play which prevent any of the shareholders/board members from acting contrary to the interests of the new owners.
- Deciding to demerger
Demerger involves partitioning the company so that each shareholder takes over a part of the business. There are two routes to demerger: statutory and non-statutory. For a statutory demerger, Inland Revenue clearance can be requested (under ICTA 1988 S213), which allows assets to be divided and inter-company loans written off with favourable tax treatment, allowing a smooth transition to running a business as two or more distinct entities.
A non-statutory demerger (under the Insolvency Act 1986 S110) does not require court approval and allows business assets to be distributed to new companies which can then be sold, whilst the original company is wound up.
- Management buy out (MBO)
If some of the management team within the company decide to purchase the company and carry on trading, they will need to raise sufficient finance and create a new holding company to buy out the selling/dissenting member. Venture capitalists may be sought to invest in the ‘new’ company. Almost invariably the financial assistance in a MBO will be dealt with under what are known as the whitewash procedures of the Companies Acts. One advantage of an MBO is that it allows the dissenting parties to leave the company, however, it does also mean that the full value of the company may not be realised, because a discount is generally allowed in dealing with the previously employed management team
- Company Purchase of Own Shares
This is an often overlooked method of resolution. In a number of instances funds are not available to individuals for the purpose of acquiring equity from a dissenting shareholder. Provided that the company has sufficient distributable reserves and the cash flow to support the payment, there is a mechanism whereby advanced clearance may be obtained from the Revenue to allow the company to purchase its own share capital leaving the desired shareholder position after the event.
- Arbitration/Alternative Dispute Resolution
Arbitration demands that a third party can reach a decision regarding the fate of the firm and tends therefore to be the recourse of organisations that are embroiled in deep-routed disagreements, to the extent that they can no longer communicate effectively. Once the terms of the arbitration are agreed and entered into the parties will be allowed to make representations as to their case and these will assist the appointed arbitrator in reaching a decision. All parties will be bound by the decision made by the arbitrator and generally the decision will be coupled with a recommendation as to how the overall costs will be split between the parties.
- Liquidation
While liquidation protects the base value of the company, it generally makes no realisation of the value of goodwill, so the overall value of the business assets can be diminished. There is also an additional cost involved, for the professional Insolvency Expert to deal with the process, which can also take quite a long time to complete, given the formalities involved. On the positive side however, there can be business asset taper relief for capital gains tax purposes if the procedure is conducted speedily.
Conclusion
While no entrepreneur wants to contemplate the possible break down of a friendship or partnership leading to their business needing to be dissolved, it is clearly prudent to make provision for such eventualities. The best advice is to ensure clear agreements are in place at the time the business venture is established to ensure that all parties receive what they feel is a fair share in the event of a boardroom ‘bust-up’ and that the company itself is given every chance of survival, or that it is dissolved in the fairest and most tax efficient way possible.