Q&A: Legal precautions to take when starting a business with a friend

July 2, 2012

This article was written for and first featured in Financial Times

My best friend and I have always wanted to start our own business. We finally took the plunge and our website design company has grown quickly. We each hold 40 per cent of shares in the new company, with the remainder of the equity held by a family friend, who provided initial equity funding. We have trademarked the business name and just signed the lease on our new premises. The investor has asked to see a proposed shareholders’ agreement. My friend thinks we don’t need one, as we are unlikely to fall out. Can you advise?

Starting a business with friends should not negate the need for formal arrangements. These friendships may not have been tested by the daily strain of running a business together.

A shareholders’ agreement codifies your business relationship and should prevent the manipulation of personal friendships, if relations subsequently deteriorate.

Principally, a shareholders’ agreement regulates the relationship between the company and its shareholders. Yet it may also regulate the relationship between majority and minority shareholders and those shareholders working full time in the business and those taking a more passive role.

As well as dealing with issues such as who has the right to sit on the board, dividend policy, consent matters, etc, the shareholder agreement should also include restrictive covenants (providing protection for the business if a shareholder departs). The company may have been launched in a blaze of optimism but you should consider what might happen in the future. For example, which of the shareholders is on standby to provide any additional funding if the bank stops lending? How might the deadlock be broken if the shareholders fall out? These questions, and many more, should be posed to the participants before the business is launched. The negotiation of the shareholders’ agreement provides an excellent opportunity to make sure everybody is on the same page as you consider taking your business to the next stage.

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