A shareholder dispute won’t look as cute
Sitting at the back of the public gallery in court, Kenny looks nothing like the youthful 25 year old prodigy behind one of the country’s fastest growing startups. His hair is dishevelled and he has slept a total of five hours over the past three days: he is being sued by his childhood friend and former business partner Mike. What started out as an optimistic, friendly venture has now spiralled into years of litigation and mud-slinging. Mike claims that when their earlier business venture fell apart, Kenny took all of their shared information, research and groundwork, and used it to springboard his own company to greater heights. Kenny’s legal fees has now eaten into his profit margin and his company faces significant financial exposure in the event of an unfavourable court decision.
Kenny’s situation is not uncommon. The lure of leaving salaried employment and “doing your own thing” has always been a driving force behind the creation of many startups. Unfortunately, statistics don’t lie: nine of ten start-ups will fail. Based on an analysis of 101 startup post-mortems, the top 20 reasons for startup failure includes issues like running out of cash, disharmony within the team and investors, and legal challenges.
Litigation and legal disputes can drive a viable startup to the ground. Founders should consider the following issues in order to minimize the risk of litigation:
- Budget for legal expenses. One of the worst things that a business can do is to treat legal expenses as an “if and when the need arises” item. Always make provisions for, and include legal expenses as a line item in your budget. “Saving money” and skimping on getting good legal advice could come back to haunt you later if you are embroiled in litigation. If you need an example – try comparing legal fees involved in drafting a partnership agreement vs the legal fees and costs you need to pay if you end up being sued by your partner.
- Friendship doesn’t mean anything. It’s cynical, but business and friendship can be one of the most dangerous combinations. Many entrepreneurs (reasonably) start businesses with people that they know and trust, and have good relationships with. Unfortunately, this also means a general reluctance to enter into a shareholders agreements or partnership agreements. “I trust him” is often used as a reason as to why a contract is not needed. This is optimistic but makes poor business sense. A fair proportion of corporate litigation cases we handle involve family members and people who were once very good friends. Shareholders agreements or partnership agreements will allow all parties to clearly identify their roles, responsibilities and rights. Don’t be afraid to raise the difficult questions. If your partners are serious about the business, they would understand the importance of entering into a formal agreement.
- Behave ethically. Having a sustainable business is all about having integrity, which means always doing the right thing. Unethical behaviour comes with serious consequences, be it compliance costs, fines, legal fees and even jail time – maybe not now, maybe not in the near future, but it will eventually happen. Also – don’t mix your personal finances with business expenses.
- Intellectual Property. Make sure you own your intellectual property. Intellectual Property is one of the most valuable assets to your business and should not be taken lightly. For example – if you asked someone to help you create your company logo – do you know if you own the rights to the logo or does the creator own it?
- Clear Communication. Dan Oswald said: “Communication must be HOT : Honest, Open and Two-Way”. There must always be open and honest communication with your investors and shareholders. Don’t hide bad news – deal with it up front to prevent any miscommunication and work on an action plan to solve problems. Also, you should always listen to any concerns raised by your investors and shareholders.
No venture will ever be 100% risk free and very few new businesses will have the financial capability to survive litigation, even if it is a frivolous claim. It is good business sense to do what you can to avoid it.
English poet Joseph Malins once said:
“Better put a strong fence round the top of the cliff;
Than an ambulance down in the valley.”
Start working on your fence… and get good legal advice.
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ABOUT THE AUTHOR. Donovan Cheah is a partner at Donovan & Ho. He is an advocate and solicitor of the High Court of Malaya, and his writings have been featured in publications like The Star, the American Chamber of Commerce updates, and Asialaw.
