Legal Eagle Advice: Case Examples for Small Businesses to Take Note Of (Part 2)!

Nick Gould Partner / Solicitor at www.aria-grace.com has been providing us with his legal advice and expertise for over 12-years here he provides case examples that small companies and start-ups can learn from…

‘I’ve been working with Fashion-Enter / FashionCapital for a while. I like to think I’m a commercially minded, deal doing lawyer. I give seminars to start-ups and growing companies. I know that (most) small companies / start-ups, in particular, tend to think asking a lawyer to deal with almost anything is a waste of time and / or money. But that, of course, depends on which lawyer you ask and what you think needs to be done. In a few short notes over the next few weeks I’ll try and give you some ideas to think about.

My number one rule is always to document everything – whatever it is, write it down / keep some sort of record of what you have agreed. Following on from last week here are two more examples (below) and I’ll then discuss why I think common sense is so important when thinking about commercial / contractual arrangements and the downsides of it too often being ignored. 

These are true stories…

Example 1

Smith owns all of the shares in a small private manufacturing company. The company is doing well but Smith is not getting any younger and wants to slow down. He brings into his company, where he is currently sole shareholder and sole director, Jones. He sells Jones 25% of his shareholding for £25,000 and they agree verbally that if Jones leaves, she will resell the shares to Smith. Five years later the company has expanded dramatically and is making very large profits. It has trebled its workforce and can barely keep up with its orders. However, Smith and Jones are unable to carry on working together and Jones wants out. Smith says that’s fine and he will buy the shares back from Jones for the same price at which Jones acquired them, i.e. £25,000. Jones is not happy! She suggests that the price for the shares should reflect the massive rise in the company’s profitability over the last few years and requests a figure twenty times the amount offered. There is no documentation to assist. A simple agreement (even if covering little else) might have included words to the effect that “if Jones leave, her shares will be valued by an independent third party (which may include the company’s auditors), and such valuation will be the price at which Smith will purchase those shares”.  Of course, the clause could have been slightly (or much) longer but even basic wording such as that ought to have done the trick. In the end – and this is based on a set of facts almost identical to the example given – the parties agreed a very expensive deal for Smith on the steps of the court. As I recall (and this was more than 25 years ago, but it has obviously stuck in my mind), the total bill, including the cost for Smith buy back the shares and the legal fees for both parties, was in the region of £750,000. The initial price that Mr Jones paid for the shares was about £4,000.

Example 2

Blue and Grey each own 50% of the shares in a private limited company. They are the only directors and shareholders. There is no shareholders’ agreement or any other written arrangements between them, they decide they don’t want to “waste their money”. After some time working together, they disagree entirely about the future direction of the company and there is a complete breakdown in trust and confidence between the two of them.   The company is profitable and has plenty of cash in the bank. Neither of them is prepared to sell shares to the other and neither of them is prepared to sell shares to a third party. Each wants total control of the business.  There are legal mechanisms by which they could deal with this but that would involve an application to the High Court. Neither is prepared to pay to initiate such proceedings. Because of the mistrust between the parties, the bank accounts are frozen. The company, therefore, cannot pay its debts even though there is plenty of cash “available”. In the end after several weeks of fruitless negotiations between them, they get some sensible and commercial advice from their respective lawyers, and they come to a settlement – although not necessarily the best one. It does not really matter what that settlement was, why? Because during the interim period the customer base of the company suffered badly. The company lost the confidence of its employees and its suppliers. There was a sense of mistrust between the two parties on an on-going basis and six months later the company was sold for a significant discount to its true value. Both shareholders ended up with a lot less than they would have wanted. 

More from Nick…

Tap the links to read: 

Legal Eagle Advice: Case Examples for Small Businesses to Take Note Of

Legal Eagle Notes: The Value of a Contract in Writing

Legal Eagle Notes: Paper Trails