The Pitfalls of a 50/50 Business Arrangement

I was recently discussing matters with two friends who have decided to set up a limited company together. Like most people setting up a company, they had incorporated their new company using Model Articles. If you are not familiar with Model Articles, these are the standard default constitutional governance documents that apply to a company’s internal management. They are a perfectly acceptable starting point, but they are generic, they are not tailored to the specific needs of your business or your relationship with your fellow shareholders.

During our conversation, it became clear that neither of them had given much thought to what their 50/50 business arrangement really meant in practice. They had ideas, enthusiasm, and a strong friendship; and they were both of the opinion that, as equal shareholders and directors, their relationship would be enough to ensure the company’s success. Unfortunately, goodwill alone does not protect a business when things go wrong.

What happens if a shareholder dies or becomes critically ill?

During our discussion, I raised some questions that neither of them had considered: what happens to their shares if one of them dies, or becomes critically ill and can no longer play an active role in the business?

Most people do not realise that if you incorporate your company under the Model Articles, or if your articles are silent on the matter, shares will automatically pass under the terms of the deceased shareholder’s will (or under the rules of intestacy if there is no will). The practical consequence is that the surviving business partner may find themselves dealing with a family member who has no interest in the business, no understanding of how it operates, and no desire to be involved but who now holds 50% of the shares.

It is always sensible at the early stages of a business to have an open and honest conversation about what should happen to shares in the event of death or incapacity. The company’s articles of association can be drafted to include specific provisions governing the transfer of shares on death, ensuring the position is clear and enforceable. As I always say, death is the only certainty in life, so it is worth putting documentation in place to deal with it properly from the outset.

Why does a 50/50 shareholding present problems?

A 50/50 shareholding means that no shareholder decision can be made without both parties agreeing. Any matter that requires shareholder approval whether it is issuing new shares, changing the company’s articles, or approving a major decision or transaction will require unanimity. If the two shareholders disagree, the company is deadlocked and the business can grind to a halt.

Model Articles do not contain any mechanism for resolving a deadlock between shareholders. It is often said that prevention is better than cure, and in the context of shareholder disputes, that could not be more true. We will always recommend that the articles of association include specific provisions to deal with a deadlock situation for example, a structured negotiation process, mediation, or ultimately a buy-out mechanism.

The importance of a shareholders’ agreement

If you still wish to use Model Articles as the basis for your company’s governance, it is always sensible to seek legal advice and implement a shareholders’ agreement alongside them. A shareholders’ agreement is a private contractual agreement between the shareholders which can address a range of important matters, including:

• how and when dividends will be declared and paid;
• restrictions on the transfer of shares;
• rights of first refusal for exiting where a shareholder wishes to sell;
• what happens to a shareholding on death or incapacity;
• mechanisms for resolving deadlock in shareholder decisions; and provisions dealing with a shareholder’s exit from the business, including where they are also an employee and leave on good or bad terms.

Shareholders’ agreement or bespoke articles?

The matters described above can be addressed either in a shareholders’ agreement or in bespoke articles of association or in a combination of both. There is an important distinction between the two:

• Articles of association are a public document filed at Companies House. They are accessible to anyone and bind all shareholders and directors, including those who join the company in the future.
• A shareholders’ agreement is a private document. Its terms remain confidential between the shareholders who are party to it.

The best approach will depend on the circumstances of your business. In many cases, a combination of bespoke articles and a shareholders’ agreement provides the most comprehensive protection with the articles of association dealing with the company’s constitutional governance and the shareholders’ agreement dealing with the more commercially sensitive arrangements between the parties.

How we can help

If you are setting up a business with a friend, family member, or colleague, we would always encourage you to take legal advice at the earliest opportunity. The cost of putting proper documentation in place at the outset is a fraction of the cost of resolving a dispute further down the line. Our corporate and commercial team regularly advises founders, family businesses, and owner-managed businesses on these issues, and we would be happy to discuss your specific circumstances.

Nana Poku is an Associate Solicitor in our Corporate & Commercial team at Fisher Jones Greenwood LLP. Her work covers a broad range of corporate transactions and commercial arrangements, including share and asset acquisitions and disposals, company restructures, shareholder agreements and articles of association, share buybacks and loan documentation. She also drafts and negotiates commercial agreements such as framework agreements, B2B terms and conditions and supply agreements.

For further information or to discuss how to prepare your business for sale, please do not hesitate to contact our team using our online contact form or call 0845 543 5700.