The Parting of the Ways

Recessional times place a variety of strains on small and medium-sized businesses, not just in relation to trading, but also in relation to their management and ownership structure.

From the matters we get involved with for clients, there can be two distinct elements to these problems.

Firstly, there is the ‘relationship breakdown’.  Directors or shareholders who used to have a good relationship suddenly find that, as the financial pressure increases, cracks start to appear in their relationship.  Questions as to whether fellow directors are pulling their weight or making the right decisions begin to arise, often leading to open hostility and a breakdown in the management’s ability to function.

A well-drafted shareholders’ agreement and directors’ service contracts make such a situation easier to deal with in terms of either managing the issues or structuring an exit.  In their absence, the business can find itself unable to function.  In such circumstances the sooner the business can get its professional advisers involved then the greater the chance of a workable solution being structured whilst there is still a business to save.

The second common element (often found in combination with the first) is when the business can simply no longer afford to support the number of directors/shareholders it used to.

The most common outcome in such circumstances is that someone has to go.

This raises a myriad of issues from employment rights to share valuations.  Again well-drafted shareholders’ agreements and directors’ service contracts will assist in this process, but ultimately it comes down to striking a deal that works for all sides.

This could involve restructuring the business to facilitate the separation, with different shareholders taking different parts of the business with them.  Alternatively, it could involve one party agreeing to sell his holding and resign his position for an agreed sum.  Agreeing what that sum should be is one thing, working out how to fund it raises a whole new set of issues.

If external funding is not readily available, then it may be possible for the company to buy the shares back.  A lack of the distributable reserves required to achieve this is not necessarily the end of the matter.  If the company has sufficient share capital/share premium account, this can potentially be used to make the acquisition if the appropriate statutory procedures are followed.

In the absence of this solution, the seller may be willing to take deferred consideration (if comfortable with the security being offered) or structure a phased exit with a commensurate reduction in drawings to help with the cash-flow.

Every situation is different and the most successful outcomes we come across have been where our clients have got us and their other professional advisers involved as early as possible to help put together a solution that stands a chance of working for all sides.

Simon Morris is a solicitor and head of Raworths’ Corporate unit. To contact Simon telephone 01423 566666 or email by email Simon.morris@raworths.co.uk.