LEGAL BRIEF with Lynch & Co
Protecting the Equity in your Business
Most business owners work hard for many years to build their business, with the expectation of one day retiring on the proceeds from selling it. Although this fairy-tale ending is true for some, the reality is that many owners are hit by “unforeseen circumstances” and the value of their equity in their business reduces rapidly – sometimes to a “fast track liquidation” value only.
In business, we all know that there are many true “unforeseen circumstances” that might arise, for which the best planning in the world will not avoid (but may mitigate). However, there is another category of “unforeseen circumstances” that are foreseeable in the sense that they can and do happen often, as professional advisers see regularly – even if you think it will never happen to you! This is where good professional advice becomes invaluable.
The foreseeable “unforeseen circumstances” often fall within one or more of the following areas:
1. Shareholder Disputes
These are more common than you think. A dispute may be openly hostile or just simmer in “quiet frustration” – neither of which is healthy for growing the business. They can be very costly to resolve, especially when the “loss of business focus” is factored in.
Most productive business relationships are simply based on trust, open communication and common sense. However, it is important to have an agreed written framework that all shareholders must sign up to (present and future), which clearly sets out what the business is all about, what each party’s rights and obligations are, what happens if certain foreseeable circumstances arise, and what happens when the truly unforeseeable happens. As businesses grow and change, so do the respective shareholder interests – and the “happy days” at the beginning may not always remain.
2. Loss of a Key Person
You may be the “key driver” behind your business, or you may have sales, technical or managerial people who might also be classified as “key” (i.e. your business would be materially and adversely impacted if they were suddenly not with you). The loss of a key person might arise for many reasons e.g. sudden illness or death; a frustrated existing executive shareholder deciding to resign but remain a “passive shareholder” against your will; or a key person (whether a shareholder or not) resigning to set up in competition.
Careful planning, along with effective contracts, corporate structuring, and related insurance advice and resulting cover are critical, and it doesn’t necessarily need to “cost the earth”. Common requirements are – having an effective shareholders agreement with clear “buy/sell” provisions; having structured insurance cover to ensure that funds will be available to enable the purchase under the “buy/sell” provisions, and to meet any change related working capital needs of the business. The result may well mean the difference between you or your wife and family receiving the cash benefit from all your hard work if death or serious illness strikes – or receiving nothing at all. It may also mean that you do not have to remain in business with your former business partner’s next-of-kin. Effective employment contracts, employee incentive models, and non-competition restraints are also important.
3. Ineffective or Risky Third Party Arrangements
Non-existent or ineffective contracts may well result in the loss of one or more key customers or key suppliers. That may result in the equity in your business plummeting. As noted above, the same risk also applies to the arrangements with your key employees. The failure to obtain sound professional advice before embarking on a venture or course of action may also be very costly, possibly eroding the value of your equity.
The good news is that it is never too late to start addressing the above issues in your business, and choosing the path towards protecting the investment you constantly work so hard for.
For further information, please contact Sean Lynch, Lynch & Co.,
Telephone 09 948 8433 or Email: sean@lynchandco.co.nz.
