Shareholder Protection
When going into business with another person you tend to do so when you share a common goal, have complimentary skill sets and work well together. If your business partner dies or is seriously incapacitated, this may leave the remaining shareholders in business with the estate of the deceased, their ex-wife/husband or the trustees of their trust.
In addition losing a major shareholder can impact business cash flow. Key accounts can come under pressure when the person they normally deal with has gone and suppliers could become cautious in providing credit or delay payments of outstanding accounts.
Banks and other commercial lenders would be reluctant to make available further credit in these circumstances and the surviving shareholder/s may also find it difficult to arrange additional lending as many business owners have mortgaged the family home to provide start up capital in the first place. The limited liability of the company is not necessarily going to provide comfort as it is common for lenders to seek personal guarantees for business loans. It is unlikely that the business will have money stashed away to account for events like these as most New Zealand businesses operate out of their overdraft facility.
This situation is usually clarified by having a shareholders agreement which outlines what happens in these events.
The share purchase or buy/sell agreement as it is otherwise known sets out the ground rules for:
• What circumstances trigger a shareholder buy out (usually death, total and permanent disability and critical illness are the main considerations)
• That the agreement is binding (you are obliged to sell or purchase shares) rather than pre-emptive (you have first right of refusal).
• How the company is valued.
• How the buy out is to be funded (usually by having appropriate insurance cover).
• What happens if there are surplus funds?
• What happens if there is a shortfall?
• Who pays the premium?
• Who owns the policies?
• Regular reviews.
• Disputes resolution agreement.
Two important points are that the agreement is binding and that there is a clear method to fund and buy out. In most circumstances insurance is the most practical method of ensuring adequate funds are available when a buy out is triggered.
