When the relationship between its two key shareholders/directors reaches an impasse, what happens? This scenario delves into the complexities of shareholder agreements, common frictions between business partners, and briefly considers whether dispute resolution mechanisms are the most appropriate pathway, highlighting the challenges and legal intricacies involved in such high-stakes corporate situations.
AdCr8 had been the brainchild of two visionary leaders, Alex Johnson and Riley Smith, who had been colleagues at a major communications group before striking out on their own 50/50 venture, jointly steering their once boutique agency to impressive heights in the competitive Australian market. After starting with a handful of small digital projects for one client, Alex and Riley were working around the clock and it was not long before they were winning major clients and taking on staff to service them, winning various industry awards, with AdCr8 on a seemingly unstoppable march. With Alex’s commercial nous and Riley’s creative vision, the agency was nimble, energetic and offered something a bit different, which was very appealing to large clients that had grown tired of working with a different kind of agency. Three years later, the agency was winning major contracts and had 50 staff, spread across Sydney and Melbourne.
However, as the agency started to grow, differences in the respective vision of the two founders and their ideas as to the best strategy for the agency began to surface. Alex had designs on the business becoming bigger at all costs, and moving AdCr8 in the direction of a full service communications agency, while Riley was principally focused on delivering a unique offering that, while perhaps smaller, could be a truly iconic creative agency that did not have to act like a major communications agency, could take on risky work, and eschew the bland corporate strategy and staid business principles that they hated so much and had run away from in their previous jobs.
While they were busy growing the agency these issues were never properly addressed because they were doing brilliant work and growing at the same time, but all of a sudden the agency had considerable value, and the two founders had barely had time to think and deal with the “elephant in the room”. Late in November the two founders were in a strategy meeting with some senior staff discussing whether to pitch for a certain client’s account, and couldn’t have had more diametrically opposed views. Then, after a few too many drinks on a rooftop at the AdCr8 Christmas party, Alex and Riley got into a heated argument in front of their senior staff leading to a very toxic working relationship. It became clear that Alex and Riley had to either sort their issues out, or separate, for the good of their staff, their clients, and the agency itself.
The situation posed a significant threat not only to the operational stability of AdCr8 but also to its market reputation and employee morale, and risked destroying all of the value that the two founders had worked so hard to create. The agency’s operational policies were not very well defined because the founders hadn’t had time to implement anything yet, and now they weren’t speaking so decision-making processes were totally stalled, causing major inefficiencies; the visible discord threatened to erode client confidence and agency standing in the market; and employee motivation and loyalty suffered, impacting productivity and talent retention.
Central to the unfolding drama was the lack of documented processes and alignment on how to handle operational matters, but also the shareholder agreement that had initially been put in place when Alex and Riley founded AdCr8. Fortunately they had been smart enough to have a shareholder agreement in place, but it was not exactly fit-for-purpose. A well-drafted shareholder agreement is crucial in outlining the rights, responsibilities, and processes for resolving disputes between shareholders, and also to handle how top-line business and operational decisions will be made. Of course, shareholder agreements don’t deal with every conceivable issue, but they do provide the pathway for shareholders to resolve major issues. In AdCr8’s case, the agreement lacked clear provisions for handling irreconcilable differences between the primary shareholders. This oversight became a critical issue, as there were no predefined mechanisms to address the deadlock or guide the process for a potential dissolution of the relationship. Because the two founders owned 50% of the agency and were its only two Directors, they were in gridlock.
To prevent such issues from manifesting and becoming huge (and expensive) issues, shareholder agreements should include provisions requiring the business to have a stated business plan, and mandate that the shareholders (and appointed Directors) keep the business on track. That way, if the shareholders find that they are not in agreement on matters of policy or strategic questions, they can refer to their agreed business plan. Of course, if they don’t agree on the business plan, that is a fairly important sign that things aren’t quite right among the shareholders. Shareholder agreements should also contain a Dispute Resolution clause for structured dispute resolution, and as a last resort, drag/tag and Buy-Sell provisions to facilitate an effective buyout process. If it is possible that the parties won’t even be able to agree on who goes and who stays, there are creative valuation methodologies like Russian Roulette provisions, whereby if two shareholders are unable to resolve their deadlock within a short period, one party can offer to buy out the other by making an offer for all of their shares with a stated purchase price – let’s say $500,000. The shareholder receiving the offer then has a short period to decide whether to accept the offer, or to buy out the other shareholder at the same purchase price and on the same terms. In other words, shareholder 1 is offering to buy shareholder 2 out at a price, and if the offer is rejected, shareholder 2 must buy out shareholder 1 at that price. The intention is to keep the shareholders honest but also to ensure that there is a quick resolution. After all, if the shareholder makes a ridiculous offer it can very quickly get turned around on them. In the case of AdCr8, incorporating these elements into the shareholder agreement might have provided a framework to manage their differences effectively, before things got way out of hand.
When conflicts escalated, AdCr8 had to navigate complex legal terrain. AdCr8’s first step was to engage in a mediation process, guided by an independent mediator. The goal was to reach an amicable resolution that would serve the best interests of both the agency and its stakeholders.
The possible outcomes of such a shareholder dispute can vary widely, from one party buying out the other to selling the agency or even dissolving the business. Valuation of one party’s shares is always a contentious issue, and shareholder agreements must provide clarity and be fair and unambiguous. Often, shareholder agreements distinguish between “good leaver” and “bad leaver” situations, and the valuations can be structured accordingly. After all, a bad leaver may be putting the business at risk and their valuation should reflect that. For AdCr8, the priority was to maintain agency continuity and protect its employees, clients, and ongoing projects. The mediation process focused on finding a solution that would allow for either an amicable separation of the shareholders or a restructuring of leadership roles that would enable the agency to continue operating effectively.
The Shareholder Dissolution Drama at AdCr8 serves as a cautionary tale for all agencies. It underscores the importance of having a comprehensive and forward-looking shareholder agreement, one that includes clear provisions for dispute resolution and scenarios of leadership breakdown. Such legal foresight is vital in safeguarding the agency’s future and ensuring that personal differences do not jeopardise the agency’s success. For agencies across Australia, this scenario is a reminder of the need for robust legal structures and mechanisms to manage internal conflicts and maintain business stability.
*Please note that the scenarios and characters depicted in this article are entirely fictional. While they are crafted to reflect real-world situations, they do not represent or refer to any specific individuals, agencies, clients, or real-life events. Any resemblance to actual persons, organisations, or actual events, past or present, is purely coincidental.