Avoid crippling your business from the start

It is a common scenario. Workmates see a gap in the market.  Maybe their employer isn’t agile enough to take advantage of it or maybe they want to run their own show.  For one reason or another they start up a company together to exploit the opportunity.

We all know someone who has done it, or perhaps you have done it yourself.

The story of Mark, Anthony and David shows how a successful business idea ended up an intransigent dispute in court between the three business founders. 

Story of a software start up

Mark, Anthony and David founded a company to develop software for use by vehicle dealerships. Mark and Anthony developed the software and David marketed it. The business was successful - especially once Toyota started recommending the software to Australian and New Zealand dealers.

It isn’t clear what caused the falling out between the founders but after about 14 years in business together, the Mark and Anthony started excluding David from managing the business.

They did not have a shareholders agreement.  A good shareholders agreement spells out each the contribution each person is required to make to the business and an exit procedure if their contribution falls short.  

For a couple of years they tried to negotiate a price to buy out David's shares but they couldn’t agree what the business was worth.  David finally sued to get the other to pay a fair price.

Value of a one third share

The process of valuing the shares wasn’t straightforward. Presumably attempting to keep costs low, a single business valuation expert was jointly appointed. The single expert valued the business at between $6.5 - $7.3 million.

Mark and Anthony got a second expert valuation of about $2.6 - $2.7 million. Their expert preferred a different valuation methodology, made different adjustments for surplus assets and removing personal expenses and used a different earnings multiplier.

The judge carefully reviewed the two expert valuations but did not adopt either.  Instead he valued the company at not less than $5.4 million.  David’s one third shareholding was worth $1.8 million.

Impact of prolonged dispute

Ultimately the dispute was finally resolved after ten years but it must have come at a high cost.

Apart from the legal and expert valuation fees which would be significant:

  • David had to wait 10 years to extract the value of his interest in the company;
  • Mark and Anthony needed to pay $1.8 million - more than they thought one third of the business was worth; and
  • The judge refused to give Mark and Anthony additional time to raise the money.

Lesson to be learned

If you set up business together, make sure you have agreed and documented your expectations about the required contribution to and exit from the business.

If a dispute crops up, it is always worth involving an independent third party to try to find a resolution which takes into account the competing commercial, personal and emotional issues at stake. 

If business owners can’t resolve a dispute between themselves, they will be forced to wait for an outcome imposed by a Court.  That will inevitably take longer, cost more and may even leave everyone dissatisfied.

Fiona McLay is an experienced litigator who helps business owners resolve disputes in a way that minimises the expense and disruption that those dispute can cause.  Follow her @BreakupBusiness or Linkedin