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What to do before you fall out with your business partners

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Thursday June 14, 2012 at 10:00am
Going into business with an ex-colleague, friend or relative may seem like a great idea, and very often is. You’ve only to look at the Steve Jobs / Steve Wozniak Apple partnership to see that. But business can be fraught with difficulties, look at the battles in Facebook between Mark Zuckerberg and the Winklevoss twins which still rumble on today.

Although no one likes to think about it when they first start-up any business partnership will have its difficulties. Some will be minor disagreements which can be settled over a pint in the local, but others could threaten the very survival of the business.

Any business lawyer will tell you that you should make specific provision for the settling of disputes between partners and shareholders, when you set up the business, not when the first major disagreement occurs. Without specific provision you have to rely on company law and case law. If you are trading via a Limited Company the Articles of Association, Companies Act 2006 and some bits of case law will provide your only guidance. If your trade is organised in a normal partnership the answer is found in the Partnership act of 1890. The position is slightly better if you trade via a Limited Liability Partnership because there should be a private LLP agreement dealing with these matters.

What happens if the partners fall out?

The Partnership Act 1980 allows all partners to take part in the business management, even if there are too many to cope with this. Majority decisions are required for daily decisions. It can be very difficult to remove a partner even if that person brings the firm into disrepute. The usual remedy is to dissolve the partnership in the event of a serious dispute.

The practical solution is to prepare a Partnership Agreement. This document should deal with matters like: drawings of partners, who manages the business and how decisions are made. It should cover how much time partners are expected to commit, holiday and leave entitlement and what happens if they are ill. Other provisions include profit sharing, admission of new partners and leaving of partners, how goodwill is dealt with and how disputes should be settled without dissolving the whole entity.

The biggest cause of partnership disputes

Usually the biggest numbers in the balance sheet over time become the value of partners’ capital accounts and the potential value of partnership goodwill. It is essential that partners agree in advance what happens to their capital when they leave the partnership. In particular how are assets valued, how is their capital repaid and over what time period.

It is similarly helpful to agree in advance whether goodwill is to be valued and if so on what basis. This is relatively easy to deal with when the numbers are small which is usually when the business is set up. But as the business grows there is more value in the goodwill, and therefore more at stake. The larger the number the greater potential for dispute in my experience.

What happens if shareholders fall out?

In a limited company with standard Articles of Association whoever owns the majority of shares (51%) runs the business. This means that two minority shareholders may be able to act together to exclude other shareholders if their combined holding gives them control. A shareholder wanting to cash in their shares could find this difficult to do, if the other shareholders won’t cooperate.

For many family owned and owner managed businesses these legal defaults may not be suitable and a Shareholder Agreement becomes necessary. Such an agreement would typically include procedures for directors to follow in their day to day management of the company, a list of matters needing majority agreement and rules on appointment of directors. There would also be detailed provision for transfer of shares, method of valuation and issuing new company shares.

With company and partnership disputes the bigger the balance sheet gets the more is at stake for individual members and so dispute is more likely and harder to resolve. Provision for transfer of shares and the protection of minority shareholders are particularly important if the value of minority shareholders is to be protected.

Hopefully you won’t have experienced these kind of disputes in your business, but it might just be a matter of time. Reviewing the rules on which your company operates and considering whether there is adequate provision might be something to set your mind to one of these rainy weekends. And if you are concerned about how your business is set up and whether you have appropriate provisions in place to protect all directors and shareholders give me a call.

Andy Parker
Chartered Accountant Birmingham

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Parker Chartered Accountants and Financial Advisors is the trading name for PLW Advisors Ltd (Registered No. 10396831), and Parker Financial Planning LLP (Registered No. OC347027). Parker Financial Planning LLP is authorised and regulated by the Financial Conduct Authority. All companies are registered in England and Wales – registered office contact details here