Starting your company with a friend or colleague can double your chances of success if things go well, or increase the likelihood of conflict and failure. This article is written for 2 founders who are equal shareholders.  Each will be appointed a director and will therefore have the same voting rights.  This means that where there are disputes, decisions will be deadlocked until both founders can agree on a solution.  A well-drafted Shareholders Agreement will set out a path to make decisions and resolve disputes, to help avoid the stress, time and cost of a breakdown of the relationship.

Roles and obligations

The Shareholders Agreement should include a clear description of the roles and obligations of each founder. This should be based on the skills of each founder. The description needs to give a broad outline, but be sufficiently flexible to allow for the changes that often occur in a new business.

New shares

Any issuance of new shares should require unanimous approval.  It is not workable if either 50% shareholder can unilaterally decide to issue more shares.  Either shareholder could then issue more shares to themselves or any person that they like.

First right of refusal

What is a first right of refusal?  A shareholder who wishes to sell their shares must give notice to the other shareholder and provide him or her with an option to purchase those shares. This is particularly important where there are only 2 shareholders, as otherwise the selling shareholder could half of your company to a third party that you do not know or approve of.

Event of default

All Shareholders Agreements should have a clause which deals with events of default. Events of default include situations where a shareholder becomes mentally incapable, is incapacitated, breaches duties under the Corporations Act, engages in conduct which brings the company into disrepute, etc.  The other co-founder is likely to want to purchase the shares.  A well-drafted Shareholders Agreements will include a valuation price, agreed formula, or agreed way to value the shares, to know the purchase price.

Dispute resolution

As there is only 2 of you, it is important that disputes can be resolved in efficiently. The Shareholders Agreement should set out the process of how disputes will be resolved.  This may involve a series of steps, e.g. first meet in good faith, then meet with an adviser, then have mediation or another alternative dispute resolution processes.

Termination and restraint

The Shareholders Agreement should deal with how and when the relationship between the founders will end. It is important to include a non-compete/restraint of trade clause.  The exiting shareholder should not be able to, directly or indirectly become involved with another entity which competes with the company, and not be able to canvass, solicitor or entice away any clients, suppliers, agents, or representatives of the company.

Conclusion

Without a well-drafted shareholders agreement, roles, decision making and exit provisions, may be unclear.   If a dispute between the founders escalates to legal proceedings, more often than not, the only feasible option is to wind up the company. So before you and your business partner launch into setting up the company, put some thought into how you will work together and resolve disputes, and most importantly, speak to a business lawyer to discuss all your concerns!

Lachlan McKnight

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