Making Sense of Legal agreements and Ownership Structures

I sat across the table from a family who looked back at me with bewilderment. I had just gone through the details of their corporate ownership structure with them, explaining who owned what shares, who had voting control, what common shares and preferred shares were, and what different classes of shares meant. Their blank stares told me that they had never really understood the terminology and never fully appreciated the implications.

This was not a unique situation, and I have often found that families have not done their homework before entering into a new ownership structure. That is not to say that moving to a new ownership structure is not beneficial and can confer considerable advantages, but just that decisions are often made in isolation of understanding.

The family across the table then passed me their draft shareholder’s agreement. They understood enough to know that they should have one but had never fully explored what they wanted one to say. They explained that they had asked for an example document and that a lawyer had offered them the one that I was now reading. It was a reasonably standard unanimous shareholder’s agreement (USA) and had all the clauses I would expect to see. The problem was that it was a standard document for a city company with unrelated owners and had clauses and wording that would be unlikely to fit well with a family-owned farming company.

I asked each family member what they thought of the document and each shrugged and said that they had no idea what it actually said. What they were highlighting was the other problem with legal agreements, that they are written in a style that is often very difficult for most people to understand.

I am a huge proponent of legal agreements for situations where family members enter into any form of joint ownership or joint use of assets. This includes shareholder agreements, partnership agreements and joint venture agreements. The agreements are there for the situations that go bad. Situations like Death, Divorce, Disagreement, Disability and Disillusionment (the five “D’s”). They are also there to set out some of the rules of ownership such as dividend policies, decision making systems, what should happen if someone wants to leave and how any life insurance should be dealt with. They might also include rules on inheritance which can be extremely important in ensuring the transgenerational longevity of the business.

The thing with legal agreements is that they need to be written while everyone is agreeing. They are almost impossible to create once a situation has deteriorated. So, they need to be written at a time when most family owners feel the least need for them, and this is often why they are neglected. More importantly, they need to be understood, they need to address the family’s unique situation and cannot be “off the shelf” templated versions. Yes, each standard clause might remain valid, but it is the detail below each clause which will be important to discuss. This understanding can be difficult when the legal language used makes reading the document seem daunting.

My suggestion for legal agreements is this: That the family first explores and understands what clauses or main topics should be in such an agreement. They then discuss and agree what the details under each heading should say in plain language and only after this is done should they ask a lawyer to interpret their intentions into a legally binding document.

As an example, there might be a clause headed “buy-sell” which refers to what happens when someone wants to sell out of their share of the business. The family will need to consider if these shares can be sold to non-family members, they might consider what terms should be put in place with regard to timelines and any interest component or how the shares will be valued, and each family will have a different answer that meets their needs. Once a family is comfortable with what it wants it can then instruct a lawyer to write their intentions into a legal document.

Finally, I would suggest that all situations change and that any legal agreement should be reviewed at least every three years to ensure that it still meets the needs of the family owners.

Clearly, many families struggle with the process of creating a legal agreement, but in truth, the process can be hugely beneficial in developing communication and decision making that will serve them well in the future. The process can also help farming families better understand their ownership structures. By coming together to do this, the family owners can begin to practice formal communication, dealing with disagreement and finding solutions that work for them. Often this will be driven by their own set of values and understanding these will help guide behaviour and help create a sustainable ownership system.