A key issue that may arise between shareholders is where one of the shareholders becomes the chief executive officer (CEO) of the company.
It’s never easy being the CEO and reporting to siblings who have historical injustice memories related to your mutual past.
A possible way to resolve potential disputes would be to first have the CEO as an ex-officio member of the board rather than as a director on the board.
Over the last couple of weeks, I have been covering the critical pact required between partners in a company called the shareholders agreement. It may emerge where two or more individuals have come together to form a company or a new investor puts money in an existing company.
The shareholder agreement defines the relationship of all parties from birth (or re-birth), as it were, to the point where a shareholder wishes to exit the going concern. As I’ve written before, just like in a marriage, things are always rosy at the start until they are not.
A key issue that may arise between shareholders is where one of the shareholders becomes the chief executive officer (CEO) of the company. This is particularly important in the event that the company is family-owned and siblings make up the bulk of the shareholding or where a group of friends form and invest in a company together.
Look, it’s never easy being the CEO and reporting to siblings who have historical injustice memories related to your mutual past.
There is also the unmentioned pecking order of birth, so an older sibling who is the CEO might take deep umbrage at being asked questions about her performance by her ‘kid brother’. Or get indignant when her best friend, whose children often have sleepovers at her house, is asking her why the CEO’s decision is going horribly wrong.
A possible way to resolve potential disputes would be to first have the CEO as an ex-officio member of the board rather than as a director on the board. What this does is to remove the voting rights that the CEO would have on a board reserved matter, which matters would be defined in the shareholder agreement.
These board reserved matters could include disposal of assets over a certain monetary value, acquisition of or investment in another business, entering into strategic alliances or joint ventures with other entities, borrowing by the company or perhaps even contracts which entitle an employee to a commission or profit participation above a certain monetary value.
By separating these key issues as board reserved matters, the board is then assured that the CEO cannot make drastic changes to the company without first seeking their approval.
Such approval should only be obtained once the board has thoroughly assured itself through data tabled before it, that the decision creates value for the company.
The CEO should also have a properly documented employment contract with terms and conditions that are negotiated with, and approved by, the full board. What this allows the board to do is to have the difficult conversation in the event the CEO is simply not performing or is potentially destroying value in the company.
It also prevents the CEO from becoming a hulking shadow over the company’s management without a clear way to remove her short of a Russian-style Ukrainian office invasion.
By having an employment contract for the CEO as well as making her an ex-officio member rather than a substantive director of the board, an arm's length relationship is created which gives comfort to any potential incoming investors that shareholders are ready to run the company as the professional entity it should be rather than the family personal ATM that it can morph into.
At the end of the day, shareholders in a company are human beings subject to the vicissitudes of life. Inserting a dispute resolution clause into the shareholders agreement is of paramount importance to cover the likely event that a major issue emerges in the company amongst the shareholders.
The dispute resolution clause could require that parties first get a mediator to conciliate the warring parties and where this fails, then upgrading to the business class section of arbitration could be the next reasonable step.
Where a party feels aggrieved by the arbitrator’s decision then moving to the no-holds-barred step of a court process should be the next likely option.
By clearly articulating these steps, the shareholder agreement provides a rational and layered process of trying to cool down the temperatures of shareholders who have locked horns while giving cover to those shareholders who may not be party to the dispute.
I cannot say this enough: shareholders are always happy at the beginning of a business. Until they are not. Get into a business knowing that it is guaranteed to have potholes on the journey and prepare for that. A good commercial lawyer should help you craft a decent shareholder agreement.
You should ask that lawyer for evidence of commercial law work done in the past before you contract them to write a shareholder agreement for you to avoid premium tears of shock and dismay at a poorly drafted document when things become elephant!
