The highs and lows that can cost you dearly!
Many businesses are born through a shared passion and vision between friends. Emotions are high and with full of drive, friends can often get caught up in the excitement of getting the business going. With all parties on board and a positive mindset, there isn’t really an appetite to discuss and implement contingency plans if the business was to fail. Even simple factors can be often overlooked, for example, how start-up funds are used, what each party’s roles and obligations are, reimbursement policies, and how to control and disclose financial information requirements. And in the case of any agreements made…aren't put into writing. Essentially, the ‘we’ll deal with the paperwork later’ attitude is embraced—and done so with gusto.
Fast forward a few years, and although the business is doing well, a breakdown in relationships happen, including (but certainly not limited to) the following:
- Differing views in company direction and its future (e.g. expansion, focus on its strengths).
- One person not disclosing financial troubles, causing doubts around the flow of funds and actual business profitability.
- Concerns regarding the company’s financial, accounting, and statutory obligations not being met.
- A belief that someone is not ‘pulling their weight’ or that they are ‘cooking the books’.
- Breaches of director duties.
Ultimately, this may lead to a deadlock and a lack of mutual confidence to continue managing the business; jeopardising what may be a successful business. Recently, as a result of such a deadlock, we were appointed liquidators on just and equitable grounds. The relationship between the directors had irretrievably broken down and one of the parties had applied to the court to wind up the company pursuant to section 461(1)(k) of the Corporations Act 2001.
We quickly discovered that the business itself was thriving with marginal debt, and therefore envisaged that the two parties through their respective shares would receive a healthy return. After successfully realising the company’s assets, it was time to work out how to distribute the funds; this is where the fun began!
As expected, upon meeting separately with the two parties, we were given two vastly different sets of ‘facts’.
Each party detailed bitter disputes and a colourful array of accusations of all the points listed above. Our role was, and always is, to act independently and objectively: no matter how convincing a party’s story may be. With such inconsistencies in views, as liquidators we must turn to the formal agreements. To our surprise the only common ground between the parties was that there weren’t any written agreements!
Without such guidance and the disputes around the legitimacy of how transactions were allocated, we had to reconstruct the business's entire transaction history. Line by line, we examined, critiqued, and allocated several thousand entries to put the company’s books back together. This complex task was compounded by a constant 'back and forth' with both sides on every facet of the business. With statements of verbal agreements and general understandings, we resorted to reasonableness and commerciality to make final decisions. This process was arduous, time consuming and therefore costly, which resulted in a dwindling pool of funds, and the eventual return to shareholders was made at a fraction of what they could have potentially been paid.
In times of low, these formal agreements—in writing—makes the business administration highly relevant and critical, particularly if directors continually revaluate the written agreements to ensure they fit the current business position. The comfort and sense of protection alone gives each party respite in difficult times, and worst case scenario: should the relationship not work out, the exposure is limited and gives everyone the best opportunity to maximise a return from the business.