Tales of the Unexpected

If there is one thing this pandemic has taught us, it is to expect the unexpected.

When founders start a business, if it’s going well and growing fast it’s tempting to focus on maximising returns and keeping the business heading in the right direction. It’s natural not to want to dwell on what happens if things go wrong but thinking about this is, in fact, time well spent. It’s an investment in protecting personal financial security and an important step in minimising business risk.

As businesses grow, tensions can quickly develop between founders, between founders and funders and between founders and their families. Working long hours building a business can also take a toll on health and wellbeing. Unexpected exits from a business happen all the time in tragic circumstances and in happy ones. Being prepared is crucial to avoid a serious impact on both personal finances and the financial position of the business.

So, what should founders be thinking about? The four D’s are a good starting point – death, divorce, dementia, departure. What happens to the company and to the relevant shares if any of these things happen? 

Most founders first want to think about the practicalities. How can the business operate without them? Succession planning is not something most startups are thinking about but as the company starts to grow it’s important to have a plan for who will fill the role of any key person if they are no longer available for whatever reason. If the company would need to hire someone new and pay them at market rates, is it worth looking at insurance to cover that?

Next stop is to think about what happens to shares in the company if any of the four Ds happen?

• Death - If a founder dies and leaves his shares to family members who don’t work in the business, how will that affect the running of the company? Would you want to be in business with someone else’s family members? If not, then you need to ensure that other shareholders have the right to buy the shares owned by the deceased founder - again insurance is an option to cover that cost. Are there wills in place for all shareholders? If a shareholder dies without one, then the shares will be dealt with under the intestacy laws and ultimately if a shareholder has no family entitled to the shares, they would pass to the crown.
   
• Divorce – running a business that’s growing fast puts pressure on relationships. If the articles of the company allow transfers of shares to privileged relations such as wives and children and these provisions have been used, what protections do you want in place if those people die or divorce? If the articles allow for such transfers but none have yet been made, then on a divorce a founder may be forced to transfer some of his shares to his ex-partner as part of the divorce settlement. Having an angry ex as a shareholder is unlikely to be a positive experience.
   
• Dementia – no one likes to think about losing mental or physical capacity whether due to illness or accident but it does happen and having a power of attorney in place can allow a named person to deal with your business affairs while you are incapacitated.
   
• Departure - good leaver/bad leaver provisions can be included in a company’s articles to require a departing shareholder to offer their shares for sale to the remaining shareholders at an agreed price - lower if they are a bad leaver and fair value if they are a good leaver. This can be vital to allow recruitment of new staff but such provisions need careful thought.

It’s not possible to cover every eventuality - the pandemic has clearly shown us that - but putting in place a proper shareholders’ agreement and articles of association and sorting out appropriate insurance can go a long way to addressing many of these issues. Founders can and should take steps to deal with known potential problems. All these situations will cause professional and personal difficulties for founders and their families and having a plan in place to deal with them provides founders the freedom to focus on doing what they do best – developing the business.

If you need help working through the issues raised above or putting in place appropriate documentation to protect your investment, please contact a member of our corporate team.

Disclaimer 
The matter in this publication is based on our current understanding of the law.  The information provides only an overview of the law in force at the date hereof and has been produced for general information purposes only. Professional advice should always be sought before taking any action in reliance of the information. Accordingly, Davidson Chalmers Stewart LLP does not take any responsibility for losses incurred by any person through acting or failing to act on the basis of anything contained in this publication.