Talking SME Podcast: Company Structure – Tailor Your Rule Book
Our guest on this episode of our Talking SME podcast is Sarah Liddiard, Associate Solicitor at Machins Solicitors. Sarah shares her thoughts on the importance of company structure and Shareholders Agreements. She discusses making sure your company’s legal structure is fit for purpose when the business is established and at critical change points.
She likens a Shareholders Agreement to a prenuptial agreement for companies – a way of documenting the structure of the company and a plan for how the business will be run.
A bit about Sarah
Sarah Liddiard qualified as a solicitor in 2005. She is an Associate Solicitor in the Company Commercial Department at Machins Solicitors LLP based at their Luton office. Sarah specialises in drafting commercial contracts and data protections issues and also corporate documentation for growing companies. She has worked with businesses across a range of sectors to prepare Shareholder Agreements, Supply Agreements, Manufacturing Agreements and Sponsorship Agreements. Sarah assists her clients with ensuring their commercial relationships with their suppliers and customers or co-founders of the business are properly documented.
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‘Company Structure – Tailor Your Rule Book’ is just one of in our series of podcasts where we talk about a wide range of topics. We talk with business experts, and also offer broad insights to help SMEs become more successful.
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Transcript[00:00:01.720] – Jane O’Gorman
Hello and welcome to Talking SME, our quick fire chat with business leaders. I’m Jane O’Gorman and I’m very pleased today to welcome Sarah Liddiard, Associate Solicitor with Machins. Welcome. Thank you so much for joining me today on a very sunny day. [00:00:24.070] – Sarah Liddiard
It’s my pleasure. Thanks very much for having me. [00:00:27.400] – Jane O’Gorman
Sarah. There are so many things to think about when when setting up a business and growing a business that I think sometimes we neglect the bricks and mortar that created the business in the first instance. And I can imagine you’ve had occasions where businesses have fallen foul or into difficulty as a result of not being more mindful of their company legal structure and agreements. I mean, it seems fairly straightforward, for example, to register and set up a business. [00:01:01.480] – Jane O’Gorman
And then often I think, you know, we can divert attention to operations. But I think it’d be lovely to have a chat today just really to think about how much attention legal housekeeping deserves. So, for example, how important is it to think carefully about the structure of the business? And by that I mean the legal control rather than the day-to-day operations? [00:01:29.560] – Sarah Liddiard
Yes, certainly, because I’ve seen many clients in the past that have come in to see me and don’t perhaps fully understand that there’s kind of different roles within a private limited company – someone can be a director, a shareholder and an employee of the company. So they’re sitting there with kind of three hats on. But also it’s worthwhile just kind of considering indeed the vehicle for the business in the first place, because in this country, in England and Wales, you don’t have to register if you’re starting up as a sole trader, you don’t register with a particular body just for running the business. [00:02:09.970] – Sarah Liddiard
You might obviously have to register once you’re earning enough for VAT and so on. But you don’t register the business itself, you are actually trading under your own name. You can also form a partnership, as two more people can be a partnership. And sometimes it’s important to consider, well, do I really intend to work in partnership with this person? [00:02:35.020] – Sarah Liddiard
It can actually arise, as we would say, by operation of law. So actually, it could be two friends who decide to have a side venture, maybe even doing something like doing up a house with the intention of selling it on to make a profit, could actually be viewed as a partnership under the Partnership Act so it’s important to consider, well – do we really intend to be a partnership? And today, obviously, we’re focusing on the shareholders agreement. [00:03:02.420] So they will relate to limited companies and private limited companies. And that’s probably the most popular vehicle to run the business through in this country. But it is something where you do register with Companies House when you start up. And that’s the situation where you might well require a shareholder agreement, depending on your circumstances. [00:03:31.240] – Jane O’Gorman
Sure, and it’s interesting, you touched on that private limited does tend to be probably one of the more popular routes, if you like, in terms of businesses and setting up a business. And I refer back to that initial structure. [00:03:45.370] – Jane O’Gorman
But do you think that is important to always be reviewing a company structure rather than to see it as a tick box to completing an annual confirmation statement? [00:04:00.010] – Sarah Liddiard
Yes, I certainly do think it’s worth having time to review. I mean, everyone’s busy actually running the business, but actually the gift of actually having that time, just to think, instead of just filing off a confirmation statement, you actually, you know, whilst you planning and have the time to do your business planning, you should focus really and think, well, is my share structure appropriate? Am I going to want to reward employees and make them shareholders of the business, when you know it’s a question of when should I go and get advice and of course, it won’t surprise you that I’d say always try and get that advice sooner rather than later. [00:04:46.000] – Sarah Liddiard
There’s certain things that it’s far better, certainly if you’re thinking of giving shares out to employees or transferring shares, it’s important to consider that actually that will have legal implications as well as accountancy and tax implications. But there are certain things that are much harder to do, and certainly, for example, putting a shareholders agreement in place, that’s something that you certainly should be considering if the number of shareholders are going to be increased and we’ve got a mixture of perhaps founders of the company and longer term employees, and there’s different interests between those shareholders. [00:05:29.100] – Sarah Liddiard
So we as lawyers would look at that and decide, well, what provisions need to be put into place to protect everyone’s interests. But most importantly, have that aim of allowing someone to be rewarded as being a shareholder at the same time as the founders will want to protect their interests as well. [00:05:53.890] – Jane O’Gorman
That’s really interesting thinking about kind of both angles there, you know, one in the sense of protecting the shareholders, thinking about the business structure, but also using it as a way to reward. [00:06:05.550] – Jane O’Gorman
And you touched on Shareholders Agreement there Sarah. And I think it would be really interesting if you can explain. There’s a couple of things. So firstly how bespoke articles of association, varies from your standard articles? And then, obviously having touched on that, where the importance is and where the place might be for the shareholders agreement, because I actually think that sometimes there’s a bit of confusion between the two when we think about articles and we think about shareholders agreement and it would just be lovely to have a little bit more clarification on that. [00:06:42.630] – Sarah Liddiard
Yeah, certainly. [00:06:43.530] – Sarah Liddiard
Well, to go back to basics, the private limited company, when you incorporate it, has a couple of constitutional documents and those are known as the Articles of Association and the Memorandum of Association. The memorandum, is actually part, most of it now, is part of the Articles. And it’s a document which means it’s like a rule book for the company. So the company as a legal entity has to act in accordance with its Articles. [00:07:19.380] – Sarah Liddiard
So there are certain provisions in there where, for example, it would say how many Directors it should have. And it might be that there’s always obviously going to have to be a minimum of one director. But it might also some companies might want to set a maximum number of directors for it. [00:07:40.020] – Sarah Liddiard
So when you incorporate, the vast majority of people use the model set of Articles that are available, that means that the corporation is quite quick. [00:07:51.100] – Sarah Liddiard
But the reason you might want to have a bespoke set of articles and indeed you should do, is if actually we want to have some terms in there that actually make this rule book tailored to your particular circumstance. So that might be because your company might have separate classes of shares that can declare different dividends, or there might be different shares with totally different rights, such as preference shares and ordinary shares. So those would need to be documented in the articles. [00:08:22.650] – Sarah Liddiard
And also, one of the most important things, again, is about whether there are certain rights where a shareholder can transfer shares; quite a lot of the time those transfer rights are in the articles and those articles are a public document. They have to be filed at Companies House. So the shareholders agreement in comparison is actually a written contract between shareholders. It doesn’t get filed at Companies House, so it’s a private document, and for that reason, I kind of refer to it as almost like a prenuptial agreement for companies. [00:09:08.490] – Sarah Liddiard
And it’s actually, it’s a way of documenting the structure of the company. You can include a dividend policy. You can include how frequently the directors are going to meet and have board meetings. And it is meant to be a plan for how this business is going to run. [00:09:30.750] – Sarah Liddiard
And one of the most important features of it is, it provides a bit of a check and balance because most companies, you might be like quasi partnership, where actually you’ve got a 50/50 shareholding between the two founders but the vast majority of companies might evolve over time and actually what you end up with is a majority shareholder and some minority shareholders. So we would call a majority shareholding of anything that’s 51 percent or over.
And therefore, it’s a way of actually ensuring a kind of check and balance to make sure that there is fairness between the majority and the minority shareholders. And there’s a list of what we’d call reserve matters in that shareholders agreement. So without kind of being too technical about it, we’d make sure that actually there’s certain things that all shareholders have to agree to before the company can perform a certain action.[00:10:36.000] – Sarah Liddiard
And the reason you’d want to do that is because although you might have companies where the shareholders and the directors are all the same people, and directors are involved on a day to day basis, you might have a different situation where you’ve got perhaps a couple of directors who are also shareholders, but then you’ve got some other shareholders who purely investors, they’ve provided money for the company in working capital to the company in return for equity shares. [00:11:06.060] – Sarah Liddiard
And they’re not involved on a day to day basis. So they still need some protection and to secure their investment in their money. So this shareholder’s agreement will be an agreement between the founders and those minority shareholders. And it will be a way of governing the relationship and also having an understanding about, for example, when dividends might be declared. And so it’s about everyone being very clear and as upfront as possible in terms of how this company is going to run. [00:11:41.100] – Sarah Liddiard
And again, a shareholders agreement – you might well think, well, why would I spend the time in doing this at start up, there’s so many variables. It doesn’t necessarily need to be a document that is going to be cast in stone forever.
For example, in fact, I’ve spoken to a client recently who actually is setting one up for a very short term period of about two years because they then actually want to have a discussion with their minority shareholder at that point, to see whether they actually increase their shareholding or indeed take over the whole company at that point, because they’ve predicted that their growth will be actually, by that point, one of the founders might decide, actually, I’m going to exit the business at this point.[00:12:31.340] – Sarah Liddiard
So so you can set a term on these shareholder agreements with a view to it being reviewed and varied at that point. So I hopefully that explains why that document might be useful for business people setting up, particularly when it’s perhaps a new venture or they’re working with someone who they have not previously worked with before. [00:12:55.110] – Jane O’Gorman
You know, that’s really helpful. And actually, it’s interesting because, you know, having that explanation and thinking about it when you talk about the checks and balances, the descriptive of it then certainly comes across as not something that’s a static document, you know, that you do once and it gathers dust.
But something really a bit like when I referred earlier to you reviewing the company’s structure and thinking about, you know, is it a tick box for the confirmation statement, that actually the shareholders agreement can also be something that is not set in stone and that you can set timelines to. But it also gives a good opportunity to think about the business and the plans for the future and how you want things to pan out. And as you say the transparency around it in terms of governing relationships too, that’s really helpful. So, yeah, thank you very much for that Sarah.[00:13:54.450] – Sarah Liddiard
Certainly, it’s one of those areas where, I mean, I’ve been involved where where clients have either completely started again after a certain period of time because the business has changed or indeed, they’ve just done a set of variations because they’ve had shareholders leave and new shareholders join. And we might need to put in something like a deadlock clause or so on. So it can it can be a fluid document. [00:14:22.350] – Jane O’Gorman
I guess we only need to think about the circumstances that we’re all in at the moment, you know, and things change and sometimes things may arise that we didn’t plan for, you know, and perhaps having some structure and some protection around the business. I guess it’s sometimes when there may be challenging circumstances that that’s when, you know, one might be grateful that the time had been taken to do some work around that. [00:14:53.310] – Sarah Liddiard
Yes, certainly. I mean, in fact, I recently spoke to another client who definitely had had been putting this off and actually it was the result of Brexit initially, but obviously when the pandemic hit, they were glad that they’d put in place a shareholders agreement. Because one of the most important factors is what happens if there’s long term illness or a death of a co-founder shareholder. What will happen with shares? These agreements build in a mechanism to decide how they might get offered to the continuing shareholders.
Because it might well be that the shareholder who’s exiting the company, their family might not want to get involved, but that share is an asset and that certain trigger events can mean they get offered to the other shareholders at market value or some other mechanism that’s used to value their shares, and there’s a set mechanism and there’s a route to how that that can be managed.[00:16:07.370] – Sarah Liddiard
And I know that that that helps a lot of businesspeople, because actually, again, you’re quite right. It’s something that perhaps has been at the forefront of people’s minds over the last year. And they’ve suddenly thought, well, what if …? We’re all navigating perhaps, you know, an environment where certain clients have to do wholesale restructuring of the business. Others have, because of the types of goods or services they’re providing, that they’ve actually had a much better year than they thought they would.
And either way that has actually provoked discussions internally about how either profits are extracted out more quickly than perhaps originally thought or, you know, whether their new share structure needs to be put in place and or indeed, some clients have felt now’s the time to look at having more employee engagement and they’re looking at putting perhaps employee share schemes in place. So so those all provoke a need to to look around this issue and what agreements, legal agreements need to be put in place between the company and shareholders.[00:17:19.130] – Jane O’Gorman
There’s a lot more to it, I can see. So do you have perhaps a current example that you’d be happy to share or, you know, perhaps a business or a situation that you’ve handled recently where time and money has been spent? Perhaps thinking about the company structure and where having done that, its reaped significant benefits further down the line. You know, a situation where having done the homework and having followed a process that has put some of these, if you like, processes in place, has then given benefit to the business. [00:18:07.130] – Sarah Liddiard
Certainly one particular situation springs to mind. Where the clients not looking at a long standing business trading, providing goods – commercial goods and packaging. And it’s a case where, you know, they actually never needed one because actually the relationship between the founders has been so good. But actually, they realized as a result of Brexit, that they realized they needed to put some written agreements in place.
So and they also had a director who had some health issues in the past, so it was a good opportunity for them. They came to see me and we were looking at putting an agreement in place. Which was going to govern how things like how regularly to have board meetings, they actually already had a third director of the company who’s a Non-Exec. So that proved to be a very helpful circumstance where we’ve actually got three directors on the board. So there actually is a bit of a check and balance there. And there’s an ability to avoid deadlock already because you’ve got three directors rather than just two.[00:19:27.810] – Sarah Liddiard
And I think what’s interesting, it’s certainly useful to know, is that actually you can look at getting an insurance policy in place. So effectively when when we’re looking at a situation where there might be a buyout of shares if one founder shareholder dies, an insurance policy can be put in place to actually pay out on that event to provide the funds to pay for the shares. So it can be a policy that actually can be paid for by the company, but it will then pay out in favour of one or the other shareholder. [00:20:14.130] – Sarah Liddiard
And so because we’ve got a the risk of an event happening, we can get the cover in place. And then that particular agreement contained what’s legally referred to as cross option so that they had an option, but not an obligation, to purchase the other shares in the event of the death of either of the founders. [00:20:36.630] – Sarah Liddiard
So it was a fairly balanced agreement. So they both had that opportunity. It gave them certainty. They knew that actually the other continuing shareholder would be able to carry on the business. They knew that when they came to see me that their family members didn’t want to get involved in the business. They’d simply want, you know, the money for the shares. And they had you know, they were content to know that actually that there was a route there that it could be managed.
And at the same time, we also discussed things like powers of attorney if there were long term health issues, people sometimes don’t realise and commercial clients don’t realise, actually you can get separate powers of attorney which govern your business affairs. So obviously, people, especially during the last year, might have had the powers of attorney for health and welfare issues. But actually you can have a separate power of attorney for business affairs. So that’s something that one of my colleagues in our private client department would deal with.[00:21:43.200] – Sarah Liddiard
But it kind of goes hand in hand with this planning that you do with the shareholders agreement. And again, it provides some comfort since they know that they’ve got that that particular issue dealt with. They were surprised, indeed, that actually the cover was available for both of them because in the past it hadn’t been because of particular health issue.
It meant that, you know, it was worth revisiting. And it comes back to that point we discussed earlier about actually, you know, relooking at things, do go and get updated advice, in this particular regard it was updated advice from an IFA that they were able to get particular cover and they knew that they were in a better position.[00:22:31.950] – Sarah Liddiard
And it was a document they were able to, you know, both have a copy of. It was able to be, you know, a copy was kept with their with their wills as well. So, you know, it’s there to be referred to. So they were happy that had at least allow them some peace of mind. Because, you know, as with most founders they’ve dedicated, you may be 20, even 30 years of their life to this business. [00:22:57.330] – Sarah Liddiard
They need and want to make sure that actually if the intention is that it should survive on past them, that there’s a mechanism there to allow that to happen and that there’s a fair mechanism for valuing their shares. [00:23:10.350] – Jane O’Gorman
Yeah, that’s that’s so interesting and so helpful. And in a way, doing that planning and having that reassurance is a great way to avoid probably very uncomfortable, complex discussions at a time when you really don’t want to be having them, you know. So it makes it really good sense. Thank you again for that input. Really useful. If you did have top tip Sarah for a growing business in terms of legal housekeeping and I think we’ve covered a few here. What would it be? [00:23:46.470] – Sarah Liddiard
Well, that’s a very good question. [00:23:48.870] – Sarah Liddiard
The first the first thing I would say is you do need to budget for a certain amount of perhaps legal expenditure or legal advice right at the start. [00:24:01.920] – Sarah Liddiard
A lot of businesses will say, but I can’t afford to do that yet. And I would say, well, if you can’t afford the Shareholders Agreement right at the start, do your budget to get it done within the first 18 months or two years, if you can. You know, typically, I would say to any new businesses, allow at least two thousand pounds plus VAT, perhaps for legal advice on getting a shareholder’s agreement done. [00:24:28.350] – Sarah Liddiard
But you would need to also, another top tip, is ensure that you’ve had the conversation. There are various guides out there. Certainly we provide a guide. It’s a conversation you need to have. You need to have that conversation with the co-founders about dividend policy, if the funds are needed and capital is needed to the company who’s going to provide it, is it going to be provided by by shareholders. Are you going to go and get external funding? Be aware of what issues might crop up or that you can see on the horizon and then how you’re going to deal with them. [00:25:09.870] – Sarah Liddiard
Another top tip is actually don’t be afraid of picking up the phone and getting that advice, whether it’s obviously from a lawyer or an accountant. I think there’s a lot of actions that you know once they’ve been done, it’s rather difficult to unravel or you have somehow weakened your position. [00:25:29.850] – Sarah Liddiard
And so actually, it’s far better perhaps to, you know, arrange a meeting and actually pay for some advice for a specific issue before you go ahead and do anything and and just hope for the best, because actually you might find that it’s actually then quite hard to unpick the situation. [00:25:50.580] – Sarah Liddiard
For example, I mean, a good example of this is I dealt with a company in the past that had issued shares to employees. There wasn’t any shareholder agreement. The articles didn’t deal with what happened if an employee left the company and then one of those employees actually got sacked and it was a fair dismissal. The problem was they still had the shares and it then proved a problem. [00:26:14.160] – Sarah Liddiard
And in fact, we thankfully, we were able to use another procedure in the company that took to get those shares back effectively. But they probably spent nearly the amount of money in going through that alternative procedure than they could have done with shareholders agreement and it literally would have been, you know, a couple of letters to deal with after a shareholders agreement to end the issue and get those shares back. And, you know, for that particular small company, it proved very difficult. [00:26:46.020] – Sarah Liddiard
They were effectively held to ransom in terms of declaring dividends, because if they declared it on that class of share and unfortunately they hadn’t separated that class of shares and this ex employee could have could have been due dividends, and it was not a great situation to be in. [00:27:03.680] – Sarah Liddiard
So my top tips definitely would be, you know, if you’ve got any questions, it might prove certainly less stressful, more time and cost effective to get the advice early on and ask those questions. And certainly, you know, ask the questions to get the expert advice when you need it, so that we don’t then have to try and unravel and then unpick things later on, which might actually be more expensive or certainly more time consuming. [00:27:36.430] – Jane O’Gorman
It’s like private health for business structure. It’s good health care, look after it and then you won’t have to worry about prescribing too much for the future by the sound of it. Yes, certainly. Really great. Thank you. Thank you so much, Sarah. It’s been lovely to have you joining me today and for this valuable chat. [00:28:00.510] – Sarah Liddiard
Great to speak to you too Jane. Thank you. [00:28:02.490] – Jane O’Gorman
My pleasure. And to our listeners, I hope you enjoyed Talking SME. Look out for future episodes coming soon.