The success of any small business – including innovative tech sector businesses – depends on appropriate rules governing the relationship between the owner managers. Failure to set the ground rules of that relationship can undermine the business and destroy value. The following are a few tips:
1. Roles and responsibilities. Who will do what and how you intend to achieve your goals. Keep these under review as they will develop and change over time.
2. Who owns what? If shareholders are contributing any particular assets to the new business, such as technology or intellectual property – it needs to be agreed whether these will be transferred outright or licensed to the company. A company’s value evaporates if it fails to obtain secure rights to essential technology.
3. Go legal. It is essential at an early stage, ideally at the outset, to put in place a partnership or shareholders’ agreement, taking independent legal advice as necessary. With expert guidance the process itself can be extremely rewarding because you will be forced to consider many issues that are likely to be critical going forward. Do not put this off. It will not be possible to address every eventuality so concentrate on the key issues, for example:
• agree a list of matters that are so important that they can only be done with unanimous consent and/or those that require the consent of a certain majority. For example, spending or borrowing above a specified limit; hiring and firing key employees or taking on new business partners/shareholders;
• what happens if someone wants to exit the business. If it is a company, can they sell their shares to anyone or, as is most likely, will restrictions apply on what they can do with their shares? What notice period should be given?
• can a leaver be forced to sell their shares to the remaining shareholders? If so, at what price? Will it be market value (in some or all circumstances?) and, if so, who will decide what that is? There are a number of ways in which this can be structured. The important thing is to agree what should happen in advance even if this seems so unlikely at the outset;
• agree what should happen if one of the owner managers behaves in breach of duty, is seriously and persistently under performing or is seriously ill. Can that person be forced to leave the business and if so, on whose decision? Will they be bought out for market value or at some lesser amount? Whilst rarely an easy issue to discuss, the survival of the business in tough times may ultimately depend on how these circumstances are dealt with;
• protect the business by putting in place appropriate non-compete and other post-termination restrictive covenants so that leavers cannot undermine the goodwill of the business. Lenders, investors and new business partners may also expect these provisions to be in place to protect their investment;
• agree on how profits will be distributed and how the business will be funded going forward.
4. Exit plan. Will you be seeking a trade sale or IPO and broadly in what time frame? Must everyone agree or can a majority force a sale on the minority. Addressing these issues fairly early on will help galvanise the business and its key employees to work towards that objective, especially if they are incentivised through appropriate share options.
5. Arms length dealings. Treat your business partner as just that. Put in place a formal appraisal system for all owner managers. Deal with significant and persistent under performance at an early stage: it is only fair on all concerned. If necessary, take the appropriate actions. If the only action is to force someone to leave, then make sure that you have the documentation in place to do just that in a procedure that is written, efficient and unambiguous. Nothing can paralyse a business more than an irresolvable shareholder dispute.
The above steps may seem heavy-handed in the friendly atmosphere of a new tech startup. However, with the rules in place, the chances of managing the relationship of business partners becomes more certain. What is right for the business then becomes the key driver and often the personal relationships behind the business stand a better chance of survival as a result.
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