Relationships Between Business Owners - Caution When Joining an Existing Business

Posted by Luke Mitchell on 27 April 2016
Relationships Between Business Owners - Caution When Joining an Existing Business

In our earlier blogs this month, we have focused primarily on new businesses and the importance of choosing the right ownership structure. In today's blog we will shift our focus slightly to a new owner joining an existing business and in particular, the importance of obtaining legal advice before buying in.

We often see clients who have had disputes arise with business partners. Unfortunately, some of those clients did not take the opportunity to obtain advice before finalising ownership arrangements and have signed agreements very unfavourable to them.

A recent example is a client who bought into an established professional services business. This particular individual was a smart, well qualified professional who was good at their job. Those qualities led to an offer of an equity interest in their employer.

The relevant events can be summarised as follows:

  • The client is presented with a draft Shareholders Agreement and a proposed purchase price. There are some back and forth negotiations but then discussions seem to grind to a halt. The existing principals of the firm start pushing for the deal to be finalised as quickly as possible;

  • Not wanting to lose the opportunity and against the client's better judgment, a loan is taken out and the purchase price is paid however negotiations as to the terms of the Shareholders Agreement are not finalised and the document is not signed but the client commences operating as an owner;

  • After 12 (financially successful) months, the client still has not got anywhere with the negotiations as to the Shareholders Agreement but the time and money that has been invested - and the fact that things seem to be going well – the client decides to just sign the agreement as it stands;

  • A month later, the client receives notice that their services are no longer required either as an employee or a shareholder;

  • The client receives advice that the Shareholders Agreement allows their employment and shareholding to be terminated at any time on a month’s notice;

  • The client is then presented with a severance package equivalent to one-third of the price that was paid by them to buy into the business. This too is provided for under the terms of the Shareholders Agreement;

  • The client engaged us in order to try to negotiate a better deal. In the meantime, the client tries to get on with things and uses the remainder of their funds to make a go of it on their own, setting up their own business;

  • The client then agrees, without obtaining legal advice, to perform work for some customers of his former business. The former business partners find out;

  • The Shareholders Agreement that was signed contained non-compete provisions. The formerbusiness partners commence Supreme Court proceedings against the client seeking an injunction to stop him operating his business.

After protracted negotiations, the client is able to reach an agreement with the former business partners. Significant legal costs have been incurred, but at least there is some certainty in the outcome.  However, the majority of the problems that this client encountered could have been avoided if legal advice had been obtained prior to the client paying the purchase price and signing the Shareholders Agreement.  

Over the years we have acted on many sale and purchase of business transactions and have prepared and reviewed numerous ownership agreements.  It is essential that, before making a final decision on the commencement of, or acquisition of an interest in, a business, you ensure that not only your legal interests protected, but that you receive sensible practical advice as to the many commercial and practical issues that may arise during the life of the business. We specialise in providing clarity and confidence to business operators in their legal relationships – contact us today to discuss the legal needs of your business.