News | October 31, 2024

What happens when shareholders fall out?

For Ed Starling, Wedlake Bell’s Head of Disputes, shareholder disputes are part of the routine. A rapid increase in entrepreneurs sprouting up over the past decade along with the small business boom started during COVID has left many stakeholders today at a crossroads when it comes to determining their future. Some manage to work it out, but others end up needing legal support. In the first episode of our Business of Succession series, which looks at the pressures of succession from both a commercial and personal perspective, we spoke to Ed about the issues he sees and how he and his team help to solve them.  

So Ed, why do you generally see shareholder disputes arising?

Typically, we see shareholder disputes arising due to a lack of transparency and either actual mismanagement or fears of mismanagement. Often those who are less connected with the company don’t understand what’s going on because they haven’t been fed up to date information, and so often humans fear the worst and put two and two together and get five. So transparency can be a major issue.

Secondly, I think a lack of documentation at the start can lead to serious issues down the line. Shareholder agreements are never very popular. When you’re starting a business with your best friend, actually getting a shareholder agreement in place on day one is a really valuable tool, not only to avoid disputes, but also to resolve them if a dispute does arise.

The other issues we see can stem from a desired change of direction. More and more we see businesses being built from nothing, started at someone’s kitchen table, but people grow apart. This can at times lead to one person or one group of people or investors wanting to take that business in a different direction and that doesn’t always resonate with the other main party.

Do you think that the change in government is likely to further affect that? Is there a chance that it will affect shareholder relations?

I’m not sure it will affect shareholder relations, although most changes are probably tax driven so it might drive specific shareholders to consider their own position. I don’t see it having an impact on shareholder rights per se. I think it’s more individuals making individual decisions about their own position, which can have knock on effects regarding selling their shares and putting new management in place. That, in turn, could have a knock on effect with regards to the articles of association, shareholder rights or whether you are a minority shareholder who has been prejudiced as a result of someone else coming out of a shareholding position.

We live in a world where there’s a lot of change at the moment. Are there any economic or market conditions that might affect shareholder relations?

I think one of the issues that is very hot at the moment is ESG, which is a really valid driver for many businesses, but particularly SME businesses and this can come at a cost. We have definitely seen tensions between different groups of shareholders, with some pushing for change and others less enthusiastic due to shareholder return.

Drawing on your experience, what do you think business owners and shareholders should be conscious of when it comes to maintaining good relations in the first place?

Transparency, transparency, transparency. The problem you get is that not everyone always knows what’s going on and if they don’t know what’s going on, then a vacuum can be created. If the management in particular, or parts of the management, are not transparent and open then you risk people filling that vacuum with their own assumptions. It can create unnecessary disputes, which then escalate because of emotions. So I’d say transparency certainly should be a primary priority. And then just make sure that you are aligned on your core values, because actually over time they might change. Particularly with smaller companies that have experienced rapid growth, the scenario will have also changed and people have to change with it. Sometimes it just isn’t going to work anymore. There always needs to be a sort of fundamental shift in a business in order to help it go to the next stage and that can be a challenge.

What steps would you put in place to resolve a dispute before it turns toxic?

The first bit is the boring bit around the legals, so working out what the structure is and the framework, which is your shareholders agreement if there is one, articles of association and any other sort of investor type agreements, and then finding out what’s going on, on the ground, what the issues are, if it’s just a character difference for example, which often can be the case. There are occasions though when there is a fundamental disconnect in the business or parts of the business and people are struggling to find ways of resolving it without litigation. We would always encourage some kind of alternative resolution as soon as possible, not least because, let’s be frank, the legal costs are pretty hefty and cash flow does not allow it, so we’d encourage talking it all through. It can be that just getting people around the table sometimes works. Sometimes a conversation with a respected third party, somebody who you all know, or two separate groups know and respect, can help dislodge some of the issues within a business.

There is also the option to do a mediation style resolution, which is a bit more formal, a bit more process driven. When you’ve got larger groups of investors, that can help break the ice and allow for an objective third party view. That view can make everyone stand back and think about what’s actually important.

If things have become completely untenable, what options do shareholders have?

There are always options and you should really try to make sure you exhaust all of them before heading to court. When I talk about exhausting all the options, the first one as part of a mediation is, is there one party who could buy out the other- a typical remedy which tends to work for all parties.

If the parties are so entrenched, there is no other way of avoiding some kind of litigious process, you’ve exhausted mediations and, ultimately the trust has gone, then there are a few typical scenarios.

A straightforward claim or a claim against the other shareholders or the management. You might have a minority shareholder petition, which is where a smaller, typically but not always, shareholder thinks that they have been affected by decisions of the larger party. That’s a sort of separate, different process, quite complicated but quite effective. The final (and very final) option is just to wind the company up, which is a very draconian measure, but does happen when the parties have completely broken down and they can’t find a way forward. That typically happens with smaller companies, as people will want to avoid breaking up a very profitable company, although it can happen.

There seem to be so many differences of opinion in the world right now, possibly more than we’ve had for a really long time, be that political or personal. Have you seen an increase in shareholder disputes over time? Do you think it’s becoming more of a regular thing that people can’t find common ground?

I think we have seen more shareholder disputes, but I think it’s probably more because there’s been a bit of an entrepreneurial boom. Everyone wants to start their own company and during Covid this trend really accelerated. So I would say that is more of a factor than a disconnect of values, although conflicting values can certainly play a part. More companies have been set up in the last five, ten years than in the preceding years. They’ve gone through different stages and as opposed to there being anything wrong with the system, the sheer volume has been overwhelming for many. You also have to remember that often people start businesses with their friends and or their partners, and you’ve just got to be extra careful in those scenarios. It can be very common in the HNW (high net worth) world for family members to invest in or support the ventures of other family members.

It just makes it even more important to get the documents right at the beginning, because what you don’t want to do is have a company that’s struggling or in a dispute situation with a family member, because, let’s face it, that makes for a pretty horrible Christmas dinner.