Directorship and shareholding

[Cloud]

About two years ago we started a business. There were three of us, myself, my brother and one other person. The third person knew a personal friend, who is part of a larger fund that invests in small businesses, that invested in our business.

The conditions of the investment were that it was an unsecured investment loan of R300 000 with no timeframe of return. If the company started making money though, that loan would be paid of first before any dividends would be distributed.

The three of us were appointed as directors. The investors took 33% shares and the rest was divided up between us. Myself and the other director (not my brother) received a small investment salary while we worked on getting the business off the ground.

About a year after we started, the business was still in R&D phase and the investors started withholding funds. We had gone over the initial R300k investment by this stage. I therefore volunteered to take a step back and give up my salary to ease the funding. I started working at our family business in the mean time to pay the bills, while the other person continued to receive a salary and try to further the business. It is also worth mentioning that my brother is a student and therefore had minimal time to spend on the business but was integral to the initial business idea.

I have been keeping in touch with the third person in the business as much as possible, but I am getting married in two weeks so I had been focusing on that aspect of my life. Between getting married and working for my folks I did not have much time for anything else.

About two weeks ago, the third person told me that there are some documents for me to sign. When I received the documents, it stated it wanted myself and my brother to resign as directors, and the third person to stay on with one new individual (from the investors) being appointed as director.

I was a bit take aback by this, as we do not have a shareholder's agreement in place. I have no idea what they plan to do, but as far as I know, if my brother and I resign as directors they can dilute our shares and sell it to someone else.

I find this to be unfair, as for the first year I was heavily involved in the research and development of the business and since I left not much has changed. I feel this is a bit of an underhanded attempt to completely remove my brother and myself from the business.

Any advice?

 

[w1z4rd]

Dont sign the documents. You and your brother seem to have more shares than the person trying to push you out (if I am reading this right). There is not much they can do AFAIK.

 

[Ice2Cool]

About two years ago we started a business. There were three of us, myself, my brother and one other person. The third person knew a personal friend, who is part of a larger fund that invests in small businesses, that invested in our business.

The conditions of the investment were that it was an unsecured investment loan of R300 000 with no timeframe of return. If the company started making money though, that loan would be paid of first before any dividends would be distributed.

The three of us were appointed as directors. The investors took 33% shares and the rest was divided up between us. Myself and the other director (not my brother) received a small investment salary while we worked on getting the business off the ground.

About a year after we started, the business was still in R&D phase and the investors started withholding funds. We had gone over the initial R300k investment by this stage. I therefore volunteered to take a step back and give up my salary to ease the funding. I started working at our family business in the mean time to pay the bills, while the other person continued to receive a salary and try to further the business. It is also worth mentioning that my brother is a student and therefore had minimal time to spend on the business but was integral to the initial business idea.

I have been keeping in touch with the third person in the business as much as possible, but I am getting married in two weeks so I had been focusing on that aspect of my life. Between getting married and working for my folks I did not have much time for anything else.

About two weeks ago, the third person told me that there are some documents for me to sign. When I received the documents, it stated it wanted myself and my brother to resign as directors, and the third person to stay on with one new individual (from the investors) being appointed as director.

I was a bit take aback by this, as we do not have a shareholder's agreement in place. I have no idea what they plan to do, but as far as I know, if my brother and I resign as directors they can dilute our shares and sell it to someone else.

I find this to be unfair, as for the first year I was heavily involved in the research and development of the business and since I left not much has changed. I feel this is a bit of an underhanded attempt to completely remove my brother and myself from the business.

Any advice?

Just say no and see what happens. Or, ammend the paperwork and say you are only willing to resign if you are paid out X amount of rands. I am not sure of the rules that apply when there is no shareholders agreement (was pretty sure that was a requirement for a certificate of incorporation), but I would assume that the 3rd director(not your brother) + the outside investors have a majority shareholding (>50%). This majority shareholding could be used to make you resign.

 

[Kloofvreter]

It does seem like you are not doing much for this business (due to your circumstances) and the third person is doing most of the work.

 

[The_Ogre]

It does seem like you are not doing much for this business (due to your circumstances) and the third person is doing most of the work.

This is how I read it as well

 

[Cloud]

It does seem like you are not doing much for this business (due to your circumstances) and the third person is doing most of the work.

Not really. Since I stopped working not much has changed. I couldn't afford to work for the business with no pay.

The third person and the investors have majority shares when combined, but they have no director on board.

If my brother and I resign we will end up with nothing?

 

[Kloofvreter]

Not really. Since I stopped working not much has changed. I couldn't afford to work for the business with no pay.

The third person and the investors have majority shares when combined, but they have no director on board.

If my brother and I resign we will end up with nothing?

It does not seem fair for you to lose everything you put in during startup, but I'm not sure what you expect to keep after resigning?

 

[The_Ogre]

I might be wrong on this, but if the majority shareholders (more than 50% shareholding) want you out then you have no choice.

That's the sad reality of how businesses work.

 

[ant_man]

Who Owns The IP of the business.
By when Do You Think Your Product will Be Market Ready
These points are important as Why would you want to stay part of the business if it aint producing anything.

Your Investors are EXTREMELY generous bunch of guys, normally for that type of cash they would take just under 50%, plus huge interest charges.
Been there done it and Got the T-Shirt.

 

[Ice2Cool]

Im actually not sure how this works - I know a majority shareholder could be forced to make you resign but they can't force you to sell your shares.

 

[DJ...]

There is far too much left out in this story to answer properly.

How is the company registered? Why is there no shareholders agreement? How can you resolve to vote a board in without articles of association (or similar documents) and a shareholders agreement and what exactly did you originally submit to CIPRO/CIPC? How are voting rights handled? What forms did you sign when you received the investment? If it was a loan and needs to be repaid, then why on earth would you give them a significant equity stake as well? How have you accounted for the loan in your financials? Are you completing management accounts on a frequent basis? What are you submitting to CIPC (if anything) in this respect? Is your IP registered and if so, who owns the IP?

 

[DuckieZA]

Get some legal advice. If this business has/will have some value then you must ensure that you safeguard your interests.

As a matter of interest, resigning your directorships does not affect your shareholding. The 2 things are not usually connected. One can be a shareholder but not a director or a director but not a shareholder.

But, get legal advice before you sign/do anything.

 

[DJ...]

Im actually not sure how this works - I know a majority shareholder could be forced to make you resign but they can't force you to sell your shares.

Not necessarily, on all counts. A majority shareholder might not have majority voting rights on the board, although this is highly irregular (pref shares might have more rights than ordinary shares for example). There are clauses that can be added to the shareholders agreement that can force someone's hand regarding the sale of the shares too...

 

[DJ...]

Get some legal advice. If this business has/will have some value then you must ensure that you safeguard your interests.

As a matter of interest, resigning your directorships does not affect your shareholding. The 2 things are not usually connected. One can be a shareholder but not a director or a director but not a shareholder.

But, get legal advice before you sign/do anything.

Absolutely true. The issue here is that there doesn't exist a shareholders' agreement so no directors actually exist, and there are no defined voting rights either.

Legal advice is your best bet but will be costly under these circumstances as the lawyer will have to structure all corporate agreements from the ground up, and the "investors" will have the financial backing to fight it legally. This will place the OP in a very precarious situation if he can't afford to fight it. To the best of my knowledge you cannot claim costs for this sort of lawsuit either.

Never, ever commit to action relating to investment, shareholding and voting rights without having the legal structures in place to define the processes.

OP, I think you are going to have a massive uphill battle with this and you'll find yourself playing thumbwars with an arm-wrestler...

 

[Cloud]

It does not seem fair for you to lose everything you put in during startup, but I'm not sure what you expect to keep after resigning?

At this stage I would like to keep my shares, or at least some of it. I would be willing to sell some of it to them.

Who Owns The IP of the business.
By when Do You Think Your Product will Be Market Ready
These points are important as Why would you want to stay part of the business if it aint producing anything.

Your Investors are EXTREMELY generous bunch of guys, normally for that type of cash they would take just under 50%, plus huge interest charges.
Been there done it and Got the T-Shirt.

The three of us put our idea down on a piece of paper, stating that the IP belongs to us as individuals, and signed it. I did this on advice from a family friend. This IP was never transferred to the business. If this will hold up in SA courts I am not sure.

There is far too much left out in this story to answer properly.

How is the company registered? Why is there no shareholders agreement? How can you resolve to vote a board in without articles of association (or similar documents) and a shareholders agreement and what exactly did you originally submit to CIPRO/CIPC? How are voting rights handled? What forms did you sign when you received the investment? If it was a loan and needs to be repaid, then why on earth would you give them a significant equity stake as well? How have you accounted for the loan in your financials? Are you completing management accounts on a frequent basis? What are you submitting to CIPC (if anything) in this respect? Is your IP registered and if so, who owns the IP?

Initially it was a CC, but then the investors wanted shares so we took an off the shelf company (inc) and divided the shares out of 120 so that the investors ended up with 33%.

The company is registered for sure, we opened a bank account in the business name. We have the certificate of incorporation, the shareholders certificates etc. We received a shareholders agreement template with other company details which we were told to amend with our own specifics.

None of us were qualified to do this, so it was never done. We asked the investors about it, and they said it was not really important at that stage and that the directors held the most sway.

I was not impressed with the investment loan idea either, but it came down to a take it or leave it approach and it was low risk for us. We asked them to stipulate that we would not be held personally liable for the money.

The business is not making any money, so there are no financials. It is, however, ready for market. I suspect there is a buyer or someone who is interested in investing hence they want us out so that they can recover their initial loan without having to pay us out.

 

[IzZzy]

Absolutely true. The issue here is that there doesn't exist a shareholders' agreement so no directors actually exist, and there are no defined voting rights either.

Not true. Directors don't owe their existence to a shareholders' agreement. The appointment of directors occurs in terms of common law / Companies Act.

Again, voting rights in this scenario would accord in terms of the Companies articles of association and Companies Act.

Legal advice is your best bet but will be costly under these circumstances as the lawyer will have to structure all corporate agreements from the ground up, and the "investors" will have the financial backing to fight it legally. This will place the OP in a very precarious situation if he can't afford to fight it. To the best of my knowledge you cannot claim costs for this sort of lawsuit either.

Well if they want to restructure / formalise their affairs then yes. However (without having been briefed on all facts that I need) no one party would be able to change the status quo without having at least 75% of the voting rights.

Whilst you can't 'claim' for these costs (as it isn't a lawsuit), you can contractually agree to split / share / bear them.

 

[DJ...]

So you must surely be a professional services company then, considering the type of ownership structure you've chosen. How is it not making money if this is the case and how can there possibly be a buyer? If you're not a professional services company then I'm dumbfounded as to the Section 53 registration.

Your shareholders certificates are all good and well, but they do nothing to define how shareholding is handled and how voting rights are distributed (edit, Izzy has corrected me on this one, thanks). As it stands (and iirc) legally it will revert to investment if it were taken to court, and you'd lose. You wouldn't be forced to sell your shares though as no defined process for this exists. However, and this is a big issue, Section 53 companies do not afford their directors any liability-remote luxuries - the directors are jointly responsible for all debt incurred by the company. Now considering that the "investment" was accounted for as a loan in your financials (or that you verbally agreed to this with witnesses, I presume), regardless of what the investors tell you, you are responsible for that debt, no matter what. If the company owes the debt, then you owe the debt. Now had you put together proper financials you could have accounted for it differently without the company itself incurring the debt, but you're long passed that stage, unless the investors get jelly-legs and allow for a new shareholders agreement to be put in place, but that's highly unlikely.

Also, why were no specific articles put together?

In short, I don't think you have much of a foot to stand on here after accepting a loan AND equity, without a shareholders agreement in place. What does your shareholder's certificate state? What is the allocation? Seems to me the investors have near full control of the board as it stands...

 

[Cloud]

This is not their first rodeo, and they have a personal relationship with the third person, so they do not owe my brother or myself anything.

All I really want out of this is what is fair as I really put a lot into it for the first year. I cannot afford a legal battle, and the last thing I want is to be saddled with paying back the money they invested.

The product / service is not worthless, in fact it might still go on to do very well. The three of us would never have been able to fully launch it to market with our limited resources. It was always understood that at some point it would be handed over to someone with more marketing / business experience.

I just don't feel comfortable resigning my position in the business without some kind of shareholders agreement.

 

[DJ...]

Not true. Directors don't owe their existence to a shareholders' agreement. The appointment of directors occurs in terms of common law / Companies Act.

Again, voting rights in this scenario would accord in terms of the Companies articles of association and Companies Act.

The articles weren't clearly defined here by the sounds of things so revert to shareholding. Personally I've never involved myself in any business where a shareholders' agreement does not exist, so I'm not 100% clued up here. You'd absolutely know better than me here.

The thing here is that if it is fought legally, as a businessman I'd simply dissolve the company and I could demand repayment of debt incurred by the company, and by extension, the shareholders, as they're liable (the investment was accounted for as a loan here). So the investors have them by the short and curlies in this case...

 

[Cloud]

About debt, the company does not owe anyone anything.

Everything was paid up front, in cash. So strictly speaking there is no debt to any other company. The only "debt" that exists is the unsecured loan that was given to us, which it states on signed paper we will not be held personally liable for.

When it comes to voting rights and redistribution of shares, there is no documentation in place. We have three directors and four shareholders. That's about it.

It is a services company, and we have yet to sign up one paying customer. There are interested parties though who like the idea and would potentially want to invest to take it further.

I truly wish I was more versed in company law etc. and we tried to do what we could initially to avoid something like this happening.