The problem with 50:50 companies – deadlock paralysis
September 2023
Rating system:
Reading time (1-10 minutes): 2 mins
Sophistication level (1 (idiot) – 10 (expert)): 6
Entertainment value (1 (turgid) – 10 (side-splitting)): 5
This Guide is part of my series of Guides to shareholders arrangements. My previous Guide (The top questions any shareholders agreement needs to address) can be found here.
I am now turning to deadlock companies. Deadlock companies are unusual. This is an in-depth Guide about them. So in-depth that it comes in four separate chapters.
Although this Guide is about deadlock companies there is plenty in it which is relevant to other shareholding arrangements.
This first chapter is an introductory chapter and explains why deadlock paralysis can be such a pain and the basic ways in which you can prevent it.
The problem with 50:50 deadlock companies
When two people go into business together as equals and form a company together on a 50:50 basis (ie with half the voting shares each) corporate lawyers call this a ‘deadlock company’. It’s a bit negative isn’t it? Like getting married and people calling you a deadlock couple.
Why so negative? While things are going well it can be great to be sharing everything with your business partner – your vision for the business, your exit strategy, your business development plans, your day to day decisions on matters big and small, and your appreciation of what you each bring to the business and the roles you each play.
Well, corporate lawyers can be a bit negative and focus on all the things which can go wrong. That’s part of our job. What can go wrong? Well, you might find yourselves failing to agree on any of the above – vision, exit strategy, business plans and decisions (big or small), and appreciation of each other’s input. And from little wedges great chasms can eventually develop, leading to almighty bust-ups.
And a bust-up in a 50:50 company can be extremely difficult to resolve. The company can be paralysed. Each party has only 50% of the shares each, so neither party has the shareholding power needed to do anything without the other’s agreement. No management decisions can be made. No one can sell their shares, let alone force a sale of the whole company. They can’t even wind the company up. They’re stuck together for life in a never-ending miserable impasse. Their company might grind to a halt. The bank might freeze the company accounts because there’s no clear mandate.
Impure deadlocks
A company doesn’t need to be held on a 50:50 basis (what I like to call a pure deadlock) for deadlocks to arise. Companies can have impure deadlocks as well. For example deadlocks can arise where a company’s tailored Articles of Association or a shareholders agreement include veto rights entitling certain minority shareholders to block specified decisions, such as the paying of dividends or the making of particular business decisions such as spending money on equipment or recruiting or firing key personnel. Shareholders might fall out over all sorts of things unrelated to board decisions – such as whether others are pulling their weight, or whether some want to retire or sell the company before the other wants to. But if there’s a fall out over anything, inevitably any shareholder’s threat to use any veto rights they may have to create a deadlock can be used as leverage. But unlike with ‘pure’ deadlock companies, such deadlocks don’t necessarily lead to paralysis. The company can still carry on in these situations, as the controlling shareholders still control the board and can make any decisions other than those to which veto rights apply. But such deadlocks can still be a major problem which can cause shareholder and director fallout and nastiness which can be hard to provide for in advance or to resolve once a problem arises.
Some of the same issues and possible solutions set out in this Guide for 50:50 pure deadlocks can also apply to impure deadlocks. But this Guide focuses on pure deadlocks, where a company is owned by two individuals on a 50:50 basis.
How to prevent deadlock paralysis
- Never fall out.
The obvious way to prevent deadlock paralysis is never to fall out! I have known many 50:50 companies where the owners get on terribly well and have a clear shared understanding of everything, including their respective roles, business development objectives and their exit plans. They don’t think they need a shareholders agreement to regulate their relationship. I have acted for many who have gone on to sell their companies and retire happily into the sunset without ever having put a shareholders agreement in place.
But they are the lucky ones. I have also come across many such owners who have come to grief. Stuff can happen to change things, which they haven’t anticipated and provided for. Family circumstances can change – one owner’s spouse might fall seriously ill. Personal circumstances can change – one owner might have a mid-life crisis. The business itself can change – one owner’s role might become effectively redundant. Relationships between owners can change for all sorts of reasons (or even end – the death of one 50:50 owner can cause major issues).
So I would advise anyone to consult a specialist corporate lawyer to advise on the kinds of things that they should try to anticipate and cater for in a shareholders agreement. But you can’t anticipate everything, so you also need advice on how to avoid or address the problems caused by deadlocks if something unexpected does happen.
- Avoid having a deadlock company at all.
I see quite a few companies set up where the founders don’t really have the kind of roles or relationships where a 50:50 deadlock company is needed. They don’t really need to be set up as a corporate alternative to a partnership. It can be better if one or other owner is given more control, rather than facing the risk of the company becoming paralysed by deadlock if there is any fallout over even the smallest of issues. For example, why not give one owner 51% and the other 49%? Or 50% each but with one owner having more voting power to their shares? You can then think about having a shareholders agreement and tailored Articles of Association which still balances each owner’s interests and gives the minority shareholder appropriate protections – including veto rights.
- Put in place a shareholders agreement
A well-thought out and drafted shareholders agreement can help to:
- prevent a deadlock from arising; and
- provide an alternative result to the paralysis which any deadlock could otherwise cause.
Chapter Two of this Guide explains how having a well-thought-out and well-drafted shareholders agreement can help prevent the potential paralysis caused by a fallout between the owners of a deadlock company.
Chapter Three will explain various different ways in which a shareholders agreement might help you to break through any deadlock paralysis.
Chapter Four finishes with some guidance as to other possible ways to help you resolve things, including how you can use the courts to help.
What next? Contact me for a complimentary Shareholder Arrangements’ consultation:
If you are thinking of entering into any shareholder arrangements with business partners or investors or are having any issues or difficulties with existing arrangements please feel free to email me at andrew.james@onhandcounsel.co.uk to arrange a complimentary ‘Shareholder arrangements’ consultation where I can help you to identify what might be involved and how I can help. This will help you to avoid some of the pitfalls to which you might otherwise be exposed, and give you the peace of mind of knowing that you have an approachable competent corporate lawyer ONHAND who can provide you with experienced, effective and cost-effective advice and assistance.
If you are a director or shareholder of a company and want more information on how to deal with shareholders and director relationships so you can protect the value of your business and your role in it, together with your business and exit objectives, then please contact me.
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