Have your clients properly documented their agreements in their business?
1 September 2021 by Simon Cathro
As restructuring and insolvency practitioners, we often encounter businesses failing simply because they have poor legal documents or financial systems in place. Often systems that enable a business to function never get set up properly and when difficult times are encountered by that business, the stakeholders turn to these inadequate legal documents or focus on the limited reports the financial systems can provide.
As a result, businesses often fall into insolvency because they have no visibility of their numbers and can’t make proper decisions. This can also create tension between shareholders with no agreements in place to manage that indecision or difference of opinion. A perfectly healthy business can fall to the mercy of a shareholder dispute.
Legal Documents and Financial Systems
As advisers, it is important that your clients have a proper system to manage the business. It is also important, that effective legal agreements are in place for the business to function properly.
With the advent of technology and the systems like Xero, MYOB, Salesforce and a myriad of add ons which enhance these products, a small business can set up more effectively, cheaper and quickly than ever before. However, it is often the case that those established businesses struggle to update or replace their outdated systems simply because they are unwilling to change. New competitors to the market arrive and these competitors set their business up with more powerful and cheaper technology surpassing the ‘old systems’ established businesses.
The same also applies to legal agreements. Today, we have access to legal agreements and documents that can be created, cheaper and quicker than ever before. Websites such as www.krodok.com.au is a great example of using technology to ensure that small business is properly protected. Matt Kelly of Krodok is an experienced banking and restructuring lawyer who left the traditional law firms to establish www.krodok.com.au. Whilst Krodok specialises in setting up registered secured loan documents to protect the personal investment of owners into their business, Matt says about shareholder agreements that:
“It’s essential that businesses protect their rights through the creation of a shareholder agreement. I often saw clients that had spent all their time setting up the business, promoting the business and managing the operations but who failed to set up the legal documents that become the heart and centre of how the business should operate from a legal perspective. The business then suddenly got into distress or dispute and because it had no agreements to help navigate out of that dispute it had a significant financial burden on the business.”
Matt continues to say:
“In the beginning, the clients are so excited about the business and they just want to grow and build their brand. While this is absolutely necessary, they need to accept that there needs to be a difficult discussion held which focuses on what rules should be developed for situations where the business partners may fall into dispute or one of the business owners were die or there was a divorce etc.”
As a restructuring practitioner, I have been able to restructure and sell strong businesses that fell into insolvency caused by these situations. The powers and processes allowed under a formal restructure enable me to find new owners. Those new owners have the benefit of hindsight because they see the problems that caused the financial issues. They then ensure they make the necessary changes required to properly set up legal agreements and financial systems necessary to continue and revive the business.
As advisers, you should spend the time with your clients asking the following:
What legal agreements are currently in place to structure and operate the business?
What are the tax implications of your business structure? Do I need a tax restructure?
What are the systems you use to drive the business?
Do those systems accurately reflect the true financial position of the company?
Do those systems need updating? If so, what are the best systems to use?
When designing or creating a shareholder agreement there are many issues in which the business needs to consider. Engaging a solicitor to assist is necessary. The circumstances of each business can vary significantly from the type of industry it operates, what regulations exist, who are the shareholders, who are the customers/clients and where do they operate the business.
A strong adviser will ask many questions when creating a shareholder agreement for you. Common questions can include:
Types of shares issued;
Governance around decision making;
Any particular restrictions or obligations on the directors;
Key man insurance;
Approval of expenditure or budgets;
Exit of shareholder;
Exit of key management.
A strong and effective agreement will have clear and concise clauses dealing with decision making. In addition, it will articulate a well structured approach should a dispute arise between shareholders.
To conclude, as advisers ask the question of your business clients – do you have proper legal documents and systems in place. If the answer no, then get the clients to set aside some funds to fix this.