Distributor Agreements

by Onyx Legal | Mar 30, 2023 | Law for Online Business, Legal, Protecting Small Business Online, Service Agreements

Distributor Agreements

As a small business operator in Australia, entering into a distribution agreement can be a beneficial way to expand your reach and increase sales. Distribution agreements are contracts between two parties where one party agrees to distribute the products or services of the other party in a particular territory or market. They are contracts that define the terms and conditions under which a manufacturer or wholesale supplier allows a distributor to sell or distribute its products. These agreements provide a framework for the relationship between the parties involved, including the roles, responsibilities, and obligations of each party.

For small business operators such as software providers or trade supply wholesalers, distribution agreements are particularly critical, as they provide a means of expanding their reach and increasing their customer base. They outline the terms and conditions under which the distributor is authorised to sell or distribute the manufacturer’s products. These agreements typically cover a wide range of issues, including pricing, payment terms, delivery schedules, marketing and advertising, and territory restrictions.

Key Terms in Distribution Agreements

Before we delve into the specifics of distribution agreements, it’s essential to understand the key terms that are commonly used in these agreements. The following terms are some of the most important ones:

Territory: This refers to the geographic area in which the distributor is authorised to sell the products or services. This will be particularly important to define when distributors use online marketing channels.
Products: This refers to the products or services that are being distributed.
Term: This is the length of time that the distribution agreement will be in effect.
Minimum purchase requirements: This is the minimum amount of products that the distributor is required to purchase during a specified period.
Exclusivity: This refers to the exclusive rights granted to the distributor to sell the products or services in the specified territory. Not all distribution agreements are exclusive.
Termination: This refers to the circumstances under which the distribution agreement can be ended.
Intellectual property: This refers to the ownership and use of any intellectual property, such as trademarks and copyright, associated with the products or services.

Why are Distribution Agreements Important?

Distribution agreements are essential for several reasons. Firstly, they provide a legal framework for the relationship between the parties involved, including the roles and responsibilities of each party. This helps to ensure that both parties are clear on what is expected of them and what they can expect in return.

Secondly, distribution agreements can help to protect the interests of small business operators. By defining the terms and conditions of the relationship, they can help to prevent misunderstandings, disputes, and legal issues down the track. This is particularly important for small business operators who may not have the resources to fight protracted legal battles.

Finally, distribution agreements can help small business operators to expand their reach and increase their revenue. By partnering with distributors, they can reach new markets and customers, without having to invest significant resources in marketing and advertising.

Important Considerations for Small Business Operators

As a small business operator, there are some critical considerations you should take into account when negotiating a distribution agreement. These include:

Territory

It’s important to define the territory clearly in the agreement to avoid any ambiguity. This will ensure that the distributor understands their specific rights and obligations within the designated area and there is no overlap with other distributors.

Where distribution can be promoted online, particularly through platforms like Facebook, it is important to be clear about what distributors can and cannot do, and what happens if a purchaser falls within a different territory.

Minimum Purchase Requirements

Be careful when setting minimum purchase requirements. The requirements should be reasonable and take into account the distributor’s ability to sell the products or services in the designated territory. A failure to meet a minimum can be a trigger for ending the contract.

We’ve had a client in the past who was responsible for maintaining a minimum order on a product imported from overseas. Once COVID hit, the demand for their product decreased and they were in breach of their agreement. The manufacturer provided leeway in the circumstances but has declined to provide an exclusive distribution agreement going forward, which means our client’s business is now of little value for future sale, as a competitor can now import the same thing.

Pricing and Payment Terms

Another important consideration is pricing and payment terms. This may be affected by which party holds stock pending sale. A manufacturer will usually want their production costs covered before allowing product to leave the warehouse, but a distributor may not be required to pay the full wholesale cost until the point of sale. The timing and method of payment, as well as any penalties for late payments or failing to meet minimum order requirements, need to be sufficiently clear that an independent third party (not necessarily an accountant) can work out what needs to be paid, and when just from reading the contract.

Marketing and Advertising

Marketing and advertising are critical to the success of any distribution agreement, and distributors are usually selected on the basis that they have an existing market that will purchase the product. Small business operators need to ensure that the distributor has a clear understanding of their products and target market and that they have the resources to market and advertise the products effectively.

For online retailers, influencers are like distributors. They have an existing market, and that market likes specific products and expects to hear about them from the influencer.

Exclusivity

Small business operators should carefully consider whether or not to grant exclusivity to the distributor. While exclusivity can provide the distributor with a competitive advantage, it can also limit the wholesaler’s ability to enter into agreements with other distributors in the same territory. If a distributor has exclusivity but is failing to meet minimum orders, then it may be possible to renegotiate terms to reduce their territory to open an area up to another distributor.

Termination

Termination provisions in the agreement must be clear and reasonable. This will help to avoid any disputes or legal issues if the agreement is terminated. An area that is often overlooked is the right of the manufacturer or wholesaler to revoke the distribution rights in circumstances with the distributor could bring the manufacturer into disrepute. For example, if a business decides to publicly support a particular viewpoint – eg. Margaret Court opposed the Australian same sex marriage bill and Qantas publicly supported it – and the wholesaler does not agree with that viewpoint and believes it will cast them in a poor light, then the wholesaler should have the right to end the distribution agreement.

Intellectual Property

Small business operators should be clear about their intellectual property rights and how they will be protected in the distribution agreement. The most common thing to be protected is usually a brand. There should be rules around how it can be used and displayed. It should also ensure that only legitimate products are sold and not counterfeits.

Tips for Negotiating Distribution Agreements

Negotiating distribution agreements can be challenging, whether you represent the wholesaler or manufacturer, or represent the distributor. Here are some tips to help you negotiate a fair and beneficial agreement:

Understand Your Market

Before negotiating a distribution agreement, it’s essential to understand your market and the potential demand for your products or services. This will help you to determine the appropriate territory and minimum purchase requirements.

Be Clear About Your Expectations

Be clear about your expectations regarding sales targets and marketing efforts. This will help the distributor to understand what is required of them and ensure that both parties are working towards the same goals.

Seek Legal Advice

It’s important to seek legal advice before entering into a distribution agreement. A lawyer can help you to understand the terms of the agreement and ensure that your intellectual property rights are protected, as well as making sure that any termination provisions are balanced and realistic.

Negotiate The Terms

Don’t be afraid to negotiate the terms of the agreement. Small business operators should be willing to compromise, but they should also ensure that the agreement is fair and beneficial to both parties.

Review The Agreement

Once the agreement has been negotiated, it’s essential to do some worked examples of what the terms provide so that all parties are happy the agreement meets their expectations. It is also important to ensure there are no unfair contract terms which could affect the enforceability and profitability of the agreement.

Distribution agreements are useful for small business operators and work well for businesses such as software providers or trade supply wholesalers. These agreements provide a legal framework for the relationship between a manufacturer or wholesale supplier and a distributor, defining the terms and conditions under which the distributor is authorised to sell or distribute the products. You need to carefully consider the distribution territory, pricing and payment terms, marketing and advertising, exclusivity, and term and termination when entering into a distribution agreement. By doing so, the manufacturer or wholesale supplier can protect their interests and expand their reach, increasing their revenue and success in the market.

How Can Onyx Legal Help You?

Considering becoming a distributor, or finding distributors for your products or services? Make an appointment with a member of the Onyx Legal Team to review your strategy and help create a clear, easy to use contract to support your growing business.

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What the Changes to Unfair Contract Terms Mean for Small Businesses

by Jeanette Jifkins | Feb 24, 2023 | Contracts, Law for Online Business, Legal, Protecting Small Business Online, Service Agreements

What the Changes to Unfair Contract Terms Mean for Small Businesses

Unfair Contract Terms: What Online Businesses Need to Know

Have you ever signed an online contract without fully reading or understanding its terms and conditions?

If so, you’re not alone.

Many people, from those running small businesses to vulnerable individuals, lack the knowledge, ability, time, resources, bargaining power, and patience to effectively review and negotiate terms of standard form contracts.

Some companies flatly refuse to consider changes and respond along the lines of “those are our standard terms, take it or leave it”. That approach is becoming risky.

In an attempt to try and level the playing field a little, the Federal Government recently passed a law (Treasury Laws Amendment (More Competition, Better Prices) Act 2022), which updates the Australian Consumer Law (ACL) to enable the Courts to levy penalties on businesses for including unfair contract terms in standard form and small business contracts.

If you have previously paid very little attention to your standard form contracts, or ‘adopted’ them from someone else, or had them given to you by a well-meaning colleague, now is the time to review. If you don’t review your established business practices you face potentially being held liable for quite severe penalties for seeking to impose, or enforce, any unfair contract terms.

Previously, the Courts could only declare specific terms of a contract unfair and void, but because unfair terms were not prohibited by law, the Court could not impose any penalties. Now they can.

It is expected that individuals and small businesses will have stronger bargaining powers as a result of these changes. A small business is one that employs fewer than 100 people or has an annual turnover of less than $10 million – so the majority of Australian businesses.

This still means you either have to go to court, or be taken to court, for these new penalties to be imposed.

A business will be found to have breached the law (s.23(2A) ACL) if:

(a) the person makes a contract; and

(b) the contract is a consumer contract or small business contract; and

(d) a term of the contract is unfair; and

(e) the person proposed the unfair term.

At the same time the penalties for breaches such as false or misleading representations, coercion, unconscionable conduct, supplying products that do not comply with established standards, and harassment have attracted maximum penalties for individuals of $2,500,000 and for companies at $50,000,000. Other calculations may be applied, as set out below

This means that all businesses, including those businesses mainly online, will need to be more attentive in reviewing and amending their standard form contracts to avoid breaching the revised laws and inadvertently incurring severe penalties.

As a business, you have until 10 November 2023 to review and amend your standard form contracts.

As a business, you have until 10 November 2023 to review and amend your standard form contracts.

But What Exactly Is An Unfair Contract Term?

An unfair contract term, according to the ACL, is one that causes an unreasonable or unnecessary imbalance between the parties’ rights and obligations under the contract. An unfair contract term protects one party whilst the other party bears all or most of the risk and cannot negotiate their position. So, a ‘take it or leave it’ approach to contracts.

Unfair contract terms could also include clauses that are not reasonably necessary to protect one party’s legitimate interests and would cause financial or other detriment to the other party if relied upon.

Examples of unfair contract terms include allowing one party to terminate, amend, or renew the contract while the other cannot. Other examples include allowing one party to vary the price, goods, or services without the other party’s consent or ability to end the contract if they disagree.

Consider an example of an online subscription product where the company providing the product unilaterally decides to increase the monthly plan without your consent. You have a power imbalance, with little ability to negotiate a lesser plan. The increase might even apply without you realising it – even if the business provided notice via email before the change. Not everyone gets through their emails…

Unfair contract terms have always been prohibited and the amendments to the ACL do not change the definitions or considerations of defining unfair contractual terms; instead the amendments affect how those contract terms are dealt with and the increased penalties.

The situation used to be that if you felt there were unfair contract terms in an agreement, you had to go to court to get an order saying the terms were unfair and therefore void. Now, the Court also has the ability to levy penalties.

Contract terms which the courts have previously considered to be unfair include those which:

give rise to an imbalance between the parties’ rights and obligations
are not necessary to protect any one party’s legitimate interests in a contract or project
allow one party but not the other to limit the performance required under the contract
penalise one party but not the other for breaches of the contract
allow one party but not the other to renew the contract
allow one party to vary the contract with the other party having a right to terminate for breach
allow one party to vary the price or goods or services without the other parties’ consent
allow one party to terminate on a wide range of reasons and which may have significantly adverse consequences for the other party

Maximum Penalties

Does your business have the greater of $50 million, or 3x the value of the benefit obtained, or, if the value of the benefit cannot be determined, 30 per cent of your business turnover during the period you engaged in the conduct?

Those are the maximum penalties for a company if it is found to have imposed unfair contract terms.

For individuals, it is $2,500,000.

If you are a sole trader, can you afford $2,500,000?

Fines have also been increased for breaching the Competition and Consumer Act 2010 (CCA). For example, a finding of anti-competitive behaviour can carry maximum penalties of up to $50 million or three times the value of the benefit obtained, or, if the value derived from the breach cannot be determined, 30 per cent of the company’s turnover during the period it engaged in the conduct, whichever is greater. No business can afford to take these unnecessary risks.

In addition to these penalties, the courts have the power to void, amend, or refuse to enforce part or the whole contract to remedy the loss suffered by the wronged party.

If a particular clause is deemed to be unfair, the court may also stop a party from including similar unfair terms in future standard or small business contracts.

Online businesses of all sizes and industries are at risk of breaching the revised legislation, but those that using standard form contracts are particularly exposed. To avoid these risks, all small businesses including online businesses should review their standard form contracts, obtain legal advice if necessary, and amend any outdated or unfair terms before the 12-month respite period ends on 9 November 2023.

These changes to the ACL seek to limit the negotiation power imbalance between parties in the standard form and small business contracts.

They aim to prevent companies or individuals from taking advantage of unfair contract terms and penalising those who do. As an online small business owner, it’s important to be aware of the changes and take action to ensure that your standard form contracts comply with the revised legislation.

Now is the time to review and revise any standard form contracts you may have!

How Can Onyx Legal Help You?

Send us your standard terms and conditions to advice@onyx.legal and ask for a quote to update your contracts or terms and conditions before it is too late.

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Revenue Share Deals for Online Business – the Legal Side

by Jeanette Jifkins | Jan 31, 2023 | Business Structures, Contracts, Law for Online Business, Legal

Revenue Share Deals for Online Business – the Legal Side

Revenue Share Deals for Online Business

What is a Revenue Share Deal?

Revenue share deals are a type of business agreement in which two parties agree to share the revenue generated by a specific product or service. The revenue is typically generated by sales, but it can also come from other sources such as advertising or subscriptions.

Revenue share agreements work well in the online business environment and are subtly different from a joint venture, although share many of the same features.

Whilst a joint venture might be intended for a specific project, and may also be time or project limited, revenue share deals can be perpetual and unending, provided the parties maintain their good working relationship.

Generally speaking, in a revenue share deal one partner has unique skills which can enhance the performance of a business beyond its current state (eg. strategy), and the other party has a business they want to improve, without the knowledge or experience to do so (eg. operations). As the operations person, the strategic partner often becomes your objective, trusted advisor and promoter, without having any control, ownership or decision making in the business.

This makes revenue share deals attractive to business owners who do not want to give up control or equity in what they have created, don’t have the immediate capital or cashflow to pay a high level advisor, but still want to leverage the knowledge and skills of an advisor.

It’s important to note that in a revenue share deal, both parties are sharing the risk as well as the rewards. If the product or service doesn’t sell well, both parties will earn less revenue.

Revenue Sharing Business Model Examples

1. Revenue sharing companies

Employee share schemes or other incentive programs, bonus payments to high performing distributors and distributions to shareholders are all forms of revenue sharing in companies. Whilst having an underlying performance base, typically the company retains control over the decision making around whether or not a distribution is made.

2. Sports and entertainment industries commonly use revenue sharing arrangements

Coaches and managers might take a share of the revenue a player or an entertainer receives from participating in an event. By way of example, for the popular sport of Australian Rules Football, the AFL Players’ Association requires agents to be accredited with them and publishes as a guide

“Typically agents won’t charge a fee during a player’s first season or if they are on a rookie contract. From their second year on a list, it’s usually in the 2% to five per cent range on any football payments a player earns. In relation to any commercial or promotional activities, the typical rate is 20 per cent.”

The league generates its revenue from the promotion of the game. Player salaries typically come from the revenue distribution to their club received from the governing league. This was highlighted in early 2023 when the association for rugby players rejected the salary cap issued by the NRL.

3. Commission and affiliate based arrangements

Straight commission or affiliate agreements without underlying retainers are really a revenue share model. Payment is calculated on each sale over a threshold, even if that threshold is only one sale. Sales are dependent on the efforts of the salesperson and the work of the salesperson only costs the business a percentage of the sale made. Provided that costs of the product or service are not excessive, both parties benefit.

4. Revenue Share in Ecommerce

Cost per click advertising is a form of revenue sharing, provided the click converts to a sale!

Advantages and Disadvantages of Revenue Sharing

Some Pros:

equal risk to the parties, which can mitigate potential financial losses for either party
revenue sharing is performance based – if either party stops performing, revenue decreases
both parties can benefit from increased sales and revenue
generally speaking, the contributions of the revenue share party extend the business beyond what the business owner could achieve on their own
the revenue share party doesn’t have to acquire ownership or liability for businesses it partners with, but can generate a steady stream of revenue from the relationship
easier calculation than profit share, as cost of sales is not taken into consideration

Some Challenges:

revenue sharing arrangement require a high level of trust
if a revenue party is brought in to improve strategy, the operations partner needs to be willing to change existing business practices
it can have a slow start – strategic changes may take time to produce tangible increases in revenue
an operations partner may not still see the value in the arrangement after the strategic implementations are completed and there is less input from the strategic party

Cons:

revenue share works best where the product or service being sold has an identified market and demand
revenue share works best with standard products and services, rather than bespoke offerings
both parties are likely to be dependent on each other for revenue and success, which can create tension in the relationship
the terms of the agreement may be difficult to renegotiate if one party is not satisfied with the arrangement
revenue sharing arrangements are generally not attractive to strategic partners when the business is not ready for sales, or is ready, but hasn’t made any sales
regulatory, environmental or social changes that significantly impact a business (think COVID impact on hospitality) can ruin a revenue share opportunity

Someone looking to rapidly scale may be seeking a significant involvement of the revenue share partner from the beginning, with feedback potentially reducing over time. It is important to understand that this is different from a standard coaching relationship and that the time contribution of the strategic partner may vary significantly over the life of the relationship, without changing their impact on the business, and therefore entitlement to revenue share.

Example Revenue Share Formula

Before establishing a revenue share model, it will be useful for you to consider what it is you want to achieve.

Consider an education and coaching business offering online programs with some live video coaching sessions.

The creator of the business has the knowledge and experience in the subject matter, but would like to increase sales, their current sales are $500,000 per year, which returns a profit. The creator enters into a revenue sharing agreement with a specialist online marketer for the purpose of increasing earnings from their existing products and services.

The revenue share formula might look like this:
– 12% of all sales revenue over $500,000 per annum
– sales are calculated 30 days after purchase and exclude any refunds or cancellations
– distribution of revenue share is made once per quarter for sales occurring in the 90 days ending 30 days before the end of the quarter

In this model, any additional costs incurred by the business do not need to be taken into consideration. The cost of changes in marketing recommended by the specialist online marketer will be covered in the balance (88%) of increase in revenue.

What to Think About Before Entering a Revenue Share Deal

Some things you might like to consider are:

your role and expectations in the revenue share
are you starting from a zero base, or is there existing revenue?
what skills or attributes you are looking for in a revenue share partner
the other party’s role and expectations
structuring the deal
the amount of revenue share
what happens when the revenue share is not paid?
what is the business is sold?
what happens if one party wants out?
meeting and reporting obligations

Ending a Revenue Share Agreement

It is important that you are clear on expectations and what will happen if the agreement ends. You will find the proposed revenue share agreement more useful if you can clearly identify any areas where there is potential for dispute and address those things in the agreement, up front.

Open and frank negotiation should always be the first resort (having some tough conversations) but that can stop being feasible if the relationship between the parties has broken down. It is important to have a quick and effective dispute resolution process to avoid damaging the business – the revenue source for each party. With international transactions, international commercial arbitration is often the most accessible and sensible course, but if the parties are in the same country, other options may be preferred.

It is common for there to be a form of earn out included when a revenue share agreement comes to an end by the operations partner. This is in recognition of the contribution of the strategic party’s efforts at the start of the relationship when the changes suggested took time before showing results. If the strategic partner wants out, depending on the reasons, the earn out might or might not come into effect.

It is also not unusual for a strategic partner to request an entitlement to a share of the revenue on a sale of the business, in place of that earn out arrangement. This is because revenue share agreements are so dependent on the relationship between the parties and are unlikely to be transferred to a new owner of the business.

How can Onyx Legal help you?

Make an appointment with one of our team to discuss how to implement a revenue share model for your business.
If you are considering a revenue share deal, download our Revenue Share Questionnaire here to help you get started.

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What Are Shareholder Agreements and Why Are They Important?

by Alva Li | Dec 7, 2022 | Business Structures, Buying or Selling a Business, Contracts, Dispute Resolution, Law for Online Business, Legal

What Are Shareholder Agreements and Why Are They Important?

As with all business relationships, it is important for all parties to understand their rights and responsibilities, contributions, and entitlements.

This is the same for the shareholders of a company.

If you have the chance to think through how you want to structure the company, what you want for the business, and the future in case unexpected events (like a death or disability) occur, and document those expectations, you create a situation where dispute is unlikely.

Documenting these expectations in some form (usually a shareholder agreement) is important because even if there is a dispute, you will still be able to use the terms of the shareholder agreement to resolve it with the least amount of time, effort and fuss.

Why Do You Need Shareholders Agreement?

Clients spend considerable time and money with us to resolve disputes about what they are each entitled and not entitled to, how to exit or remove someone from the company, and what will happen to those shares, IF no shareholder agreement was ever entered into.

When people stop agreeing and there is no effective mechanism to rely on to resolve the disagreement, they can be stuck in a deadlock that can only be resolved by a court.

A shareholder agreement can include a mechanism for dispute resolution that is quicker, easier and cheaper than court. Not to mention private.

Think about it.

If there are two shareholders who are also both directors (which is not an uncommon situation), then every decision about the company will have to be unanimous. It is rare for business partners to be on the same page 100% of the time, so situations will arise where the parties are deadlocked on a decision and there is no clear way forward.

A shareholder agreement can provide the way forward.

Without a shareholder agreement, court may be the only option.

Does it make sense to ‘save’ $5,000 now to lose $100,000, or your house, later?

What Is The Difference Between a Shareholder Agreement, Partnership Agreement, and Joint Venture Agreement?

There are many different types of business structures –

1. Partnership

If you are a sole trader and have decided to collaborate with another individual without setting up a company or trust, that formation is a partnership. Different sorts of entities can set up in partnership, but it tends to be most common between individuals, or their family trusts.

A partnership is not a separate legal entity, which means each partner is exposed to liabilities the partnership incurs. For example, if one partner commits fraud by stealing money from clients, whether the other partners know about it or not, the innocent partners may be required to repay the stolen money. The people who have suffered the loss don’t even have to pursue the defrauding partner first!

You would need a Partnership Agreement to clearly set out the rights and obligations of each partner, and how to exit or dissolve the partnership.

2. Joint Venture

If you wish to pool resources and share expertise with another person or entity, that formation is a joint venture. A joint venture is very similar to a partnership. It may also not be a separate legal entity by itself, but it does not have the disadvantage of liability for the actions of the other parties.

You would need a Joint Venture Agreement to define each joint venture partner’s roles and responsibilities, and entitlements.

Sometimes, a successful joint venture can lead to incorporation, or be established as a company from the start.

3. Company

A company is an incorporated entity which is separate to the people behind it (shareholders and directors). The most common structure for a company is a proprietary limited company, which means each shareholder is only liable up to the amount unpaid on their shares.

Here is the typical structure of a company:

Company
Title	Role
Shareholder	Owner
Director	Legal liability + strategy
Worker	Daily operations

In a company, the director is legally responsible for the company and its strategic direction, the people who work in the business are responsible for daily operations, and the shareholders own the company.

Even with legal responsibility, there are some decisions a director or board of directors cannot make without approval of the shareholders. Some powers are reserved to the shareholders (eg. the power to replace directors) even though they rarely have any involvement in the day-to-day business activities.

It is important to understand what ‘hat’ you are wearing in a small business and try and focus on the responsibilities of that role only, rather than trying to be everything all of the time.

As an owner of the business, you should be interested in the finances and the risks the business is taking and feel confident the board has it managed.

As a director, you should feel confident you understand your legal liability, and that the company is operating within the kind of risk tolerance appropriate to your industry, and you have a plan for where the business is headed.

Workers need to get the jobs done.

As an aside –

What is the difference between a ‘board’ and a ‘director’ or ‘the directors’?

Nothing.

The ‘board’ is just the collective name for the directors working together. In a shareholder agreement, even if there is only one director at the time it is initially signed, the document will usually refer to the board, rather than a director alone to avoid having to make changes once another director is appointed.

Whether your company has a sole director or a board, they each are responsible for making the same decisions and all members are legally responsible for the company.

What Is In a Shareholder Agreement?

As with all business relationships, it is important for all parties to understand the proposed arrangement, their contributions, entitlements, and rights and responsibilities.

Essentially, a shareholder agreement is more specific than a constitution and can cover a broader range of topics such as:

the business activity to be carried out
what each shareholder owns
whether, and if so, how new shareholders can become involved
what rights shareholders have in appointing directors
whether directors can act in the interests of their appointing shareholder
dealing with shareholder loans
outlining specific requirements for business operations, eg. business plans and budgets
when distributions can be made
how shares can be transferred
valuing the company
what happens if a director or shareholder exits
what happens if a director or shareholder does something wrong
rights if a buyer comes along
what happens to assets and intellectual property if the company is wound up
dispute resolution

How Do You Write a Shareholders Agreement?

A shareholder agreement needs to set out important matters relating to the shareholders including how they make decisions, their entitlement to dividends, and how they can exit the company or vary their interest in the company.

Other important factors include bad leaver provisions, restraint provisions and funding provisions.

Consider a scenario where you no longer wish to collaborate with the other shareholder (say, if they have acted recklessly or even fraudulently) and you want to either exit the company or remove the other person from the company, how do you do that? We have seen many situations where the lack of a Shareholders Agreement (or an effective mechanism within the Shareholders Agreement) caused stress and detriment to the shareholders as well as the company which may have to cease operations

Who writes a shareholder agreement?

We strongly recommend you go to a lawyer to help you draft your shareholders agreement.

This is a document that needs to be tailored to your situation and is not a standard form document like the company constitution which can usually be prepared by accountants when setting up the company.

Is a Shareholders Agreement a Contract?

Yes. It is a contract between the company and the shareholders, as well as between each shareholder.

It is possible, and common, to set different rights and obligations for each shareholder. For example, for a shareholder who has the knowledge and expertise to run the business or steer it in the right direction, it may be good for them to have the power to vote and make decisions for the company. On the other hand, if you have a shareholder who is an investor shareholder and purely contributes funds to the company, you may want to restrict their control over the company by giving them no voting power and only entitlement to dividends.

Does a Shareholder Agreement Need to be Signed?

Signatures are often the easiest way to prove that someone has had the opportunity to read and agree to the terms of a document.

Shareholder agreements can be signed, or a resolution (also in writing) passed unanimously by all shareholders at the time, can be passed to prove agreement and approval of the terms of the shareholder agreement. This requires a poll of shareholders.

Every shareholder, and the company, sign the shareholder agreement. If it is a resolution, then it is not passed without the unanimous approval of every shareholder.

Is a Shareholder Agreement Legally Binding?

Yes, provided that it is either signed by the company and each shareholder, or adopted by unanimous agreement of the shareholders by passing a resolution.

What Happens If You Don’t Have a Shareholder Agreement?

Your business could still operate smoothly in the absence of a shareholder agreement.

Case STUDY

Two builders set up business together on a handshake. They establish a company where they and their respective life partners are directors (4 people all together) and their respective family trusts are the shareholders. Each family trust holds 50% of the shares. The shareholders must vote on the appointment or removal of directors and a decision must be a majority decision. Because each family trust holds 50% of the shares, that means every decision has to be unanimous.

They each contribute equipment to the company.

They buy computers and motor vehicles through the company. The vehicles are expensive, under finance and registered in the name of the company, even though each builder takes one for their exclusive use and one builder puts personalised number plates on the vehicle they use.

A meeting with the company’s accountant highlights that there are unexplained transactions by one of the builders. The parties get into a dispute. As a result of the dispute, each of the life partners resign.

It takes 12 months for the builders to come to an agreement about the vehicles, equipment and jobs in the business. They cannot reach an agreement about the $300,000 + sitting in the business bank account, which was frozen by the bank pending their agreement.

To resolve the dispute, it is likely the parties will have to go to court, with the likely result that the company is wound up and the money in the bank is used to pay legal fees in getting to that decision.

If the parties had a written shareholder agreement, that dispute could have been resolved in a few short months, at a significantly lower cost.

However, not having a shareholder agreement would be problematic IF the shareholders cannot agree on a particular matter. It would be more difficult to resolve the dispute without a binding contract to rely on.

We strongly encourage you to put a Shareholders’ Agreement in place if you have not already done so, and have it regularly reviewed by a legal professional to ensure it remains up to date and compliant with regulatory requirements.

How can Onyx Legal help you?

If you have been in business with someone for a little while and everyone is still friends, or you are contemplating setting up a new company to run a business with someone new and would like to understand your legal risks, make an appointment with a member of our team.

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The 7 Key Legal Issues in Buying a Business

by Jeanette Jifkins | Nov 8, 2022 | Buying or Selling a Business, Contracts, Dispute Resolution, Law for Online Business, Legal

The 7 Key Legal Issues in Buying a Business

1. Not Rushing In

You might be incredibly excited about buying a business, and we have come across people who have decided they want to work from home, have a look on Facebook marketplace and agree to spend money they don’t have, all in one day. No consultation with a lawyer or accountant, no real understanding of what is involved in the business. It did not last and it cost them money.

We’ve also come across people who buy a business with unrealistic expectations of the work involved and an expectation that if the bank is prepared to lend them the money, they would be able to make a success of it.

A business purchase is a big commitment. It is not just the cost involved, but running the business afterwards. The next three case studies to show why it is important not to rush into a purchase.

Case Study 1

A young lady came to us with an offer from her employer to purchase the hairdressing business she was working in ‘cheap’, and to take over the lease for the business. She was keen to sign the agreement, as the seller (her boss) wanted to get out of the business before the end of financial year and it was already June.

A quick review of the deal suggested that our client would be taking on a business that was only still operating because of her work, a lease that had three years remaining and was not cheap, and the need for some refurbishment of the salon. The landlord was offering a $5,000 incentive for fitout, but the likely cost was probably going to be higher.

Fortunately, we were able to get our client to slow down and get accounting advice on the business, and to identify to our client that the seller would benefit to the tune of $30,000 per annum by being out of the lease. We encouraged our client to get an estimate of fitout renovations, which came in at a little under $70,000.

Our client decided there was no benefit in the deal to her and other opportunities were out there.

Case Study 2

A client came to us after having already taken over a beauty spa business. She thought she had a good deal because the replacement cost of the relatively new equipment in the business was significantly higher than the requested purchase price, and the vendor was providing finance.

By already being in the business and having paid a deposit of $5,000 to the seller, our client was committed, and there was nothing in writing. The client came to us desperate to get a sale agreement documented because the seller had said they would do it and hadn’t. Our client was already paying the rent, COVID restrictions came into effect and the seller was suddenly very cooperative in getting the paperwork complete. The landlord was fortunately agreeable to transferring the lease, but our client did not want us to advise on the lease, which was very basic.

Two years down the track it became apparent that the appropriate council certifications had not been obtained for the plumbing work on the premises and the premises were non-compliant. The lease and assignment of lease were silent on responsibilities and our client ended up footing the bill.

Difficulties with the lease could have been resolved before the purchase was completed if the client had not already been in the premises and operating the business before getting advice.

Case Study 3

Our client was looking to buy his first business at around $200,000 and had found a business through a broker that he was keen to buy. He arranged the finance, did his own due diligence and asked us to become involved at contract stage. The broker had prepared the contract on behalf of the seller.

When we received the business purchase contract, it was unclear from the contract what exactly our client was buying. On talking to the broker, they had moved from selling residential property into business broking and were inexperienced in the area. They were also quite frustrated that our client hadn’t simply signed the agreement and sent it back.

Without the business sale contract clearly setting out what was being sold, we couldn’t assure our client about what they would receive. In addition, the landlord wanted the buyer to enter into a new lease at a rent $10,000 per annum more than the seller had disclosed to our client.

Fortunately, our client did not rush to sign and when answers to our questions were not forthcoming, and his circumstances changed, he decided not to go ahead. In that instance he had invested in getting legal and accounting advice and told us he had a very valuable learning experience.

2. Knowing What you Are Buying

So, what are you buying? If the contract isn’t clear, then you might be handing over money and not getting what you expected. You need to know what is important to the day-to-day operations of the business and how much of that is being transferred to you. You don’t want to purchase a cafe and upon settlement, find out that the seller cleaned out all the cupboards and fridges the day before and you have to restock before you can trade.

Case Study 4

Our client was looking to buy his first business at around $200,000 and had found what he thought was a printing business and that everything was done onsite. He had no experience in printing and was planning to hire someone to run the business. He arranged the finance, and asked us to become involved at contract stage.

When we received the business purchase contract, it was unclear from the contract what exactly our client was buying. There was no mention of printing equipment, paper, card, inks or other stock. We also suggested our client carefully go through the accounts with their accountant to ensure there were sufficient profits in the business to be able to hire someone to run it. The seller was an owner/operator.

Without the business sale contract clearly setting out what was being sold, we couldn’t assure our client about what they would receive, what equipment was in the business, or even if the seller owned the equipment being used and had the right and ability to sell it.

Without ensuring the contract was clear, it is possible that our client could have only received business branding, a client list and the liability for a lease – expenses without immediate income. He would then have also had to immediately spend additional money purchasing the necessary equipment to operate the business.

Fortunately, our client did not rush to sign and when answers to our questions were not clear, and he was offered a role interstate, he decided not to go ahead. That client is looking to purchase a business for income without him having to be involved in the day to day. He hasn’t done that before and said that it had been a very worthwhile investment in getting legal and accounting advice before signing anything. He now feels better prepared to assess potential deals in the future.

3. Profit is in the Purchase

When you are buying a business, it is very important to get appropriate accounting and financial advice. It is possible to buy a business that needs to be turned around, but only if you can do so at the right price.

The profit is in the purchase.

What opportunities do you have to increase revenue immediately or very soon after you buy the business? It is not uncommon that people who are ready to sell are at that point because they have lost real interest in the business and there is lots of room for improvement. If you can see the opportunities, and know how to leverage them, then you might be looking at a good deal.

A lawyer who had bought a law practice on the Gold Coast once applied to work with Onyx Legal. They claimed they had been misled about the value of the business, paid too much and there was no opportunity to make money because the Gold Coast was a low socioeconomic area! Naturally, they didn’t get the job. You attitude to the business you are buying can influence your ability to make a success of it.

When you go into business, success or failure is up to you. Know what the business is worth once the owner walks away (are customers attached to the owner and likely to follow them?) and understand what you are willing to pay to secure that opportunity.

It is not unusual for cafes and restaurants to be sold for nominal amounts (like $1) because the owner is losing money and is better off getting out. Someone who understand the area, likely clientele, available workforce and marketing can potentially come in and make a success of it. There are stories of a Gold Coast restaurateur selling and buying back a restaurant a couple of times because he knew how to make it a success, but the purchasers didn’t.

One of the early Australian online tipping platforms was bought from the founders by a larger company, and then bought back by the founders 18 months later at a much lower cost because that company didn’t know how to make a success of it.

4. Assets vs Entities

When you buy a business, you are either buying shares in a company, in which case you are buying the history, or you are buying assets – which is everything necessary to operate a business. Assets can be tangible (like a desk) or intangible (like a website).

When you buy shares, everything in the company comes with it, so you must understand what loans or other liabilities are sitting in the company, and how they will be dealt with at settlement. Things like tax debts, overdue superannuation, bad credit ratings, court proceedings, embarrassing media stories and so on are all associated with the entity, and that is what you are buying.

When you are buying assets, you need to understand what is transferrable and what is not. Not all supply contracts are transferable without the prior approval of the customer. So if the profits in the business are in one or two large contracts and it is not clear if they are transferable, you may be losing money as soon as the purchase is completed.

These sorts of things need to be checked.

5. Transferring Intellectual Property

Intellectual property – copyright, trade marks, patents etc, need to be transferred in writing, by the owners. It is important to check who owns what when buying a business. In particular, copyright belongs to the creator unless transferred in writing. Software, graphic design, website copy etc all belong to the creator. If the creator is an employee it is ok, the copyright vests in the company, but if they started as a contractor before becoming an employee, there can be uncertainty about what they company owns and is able to sell.

Case Study 5

Our client was buying a health business and searches showed that the domain name and the website (separate things) used to advertise the business were not actually owned by the seller. A lot of patients found the business through the website. It was essential to have the sale of business contract adjusted to ensure that transfer of the domain name and website occurred as part of the sale.

Case Study 6

A client was interested in buying a business which used a particular bespoke software for all of its main operations. The due diligence process disclosed that the software developer had been contracting to the business for years and there was nothing in writing about the ownership of that software, or its ongoing use by the company. The seller was unable to produce anything in writing to show that it owned the software, even though it believed it did.

The buyer of the business walked away.

6. Competition by the Seller

Online businesses are a big area where competition is a concern after settlement. Most business sale contracts contain some form of restraint on the seller about what they can do in an area that will compete with the business you are buying after the date of the sale.

A restraint provision in an employment agreement is more likely to be enforceable when it is structured to protect the interests of the buyer, and not likely to be enforceable if it puts the seller in a position where they cannot earn a living.

Tougher restraint provisions are likely to be enforceable for commercial agreements than they are in employment situations, because the courts will also expect the parties to have made a commercial decision about what is acceptable to them, or not. This is an issue for sellers who do not carefully consider what they plan to do after completion, and how they may be limited by a restraint.

Different things that restraint provisions can cover are:

Area: Does the business operate locally, nationally, in a region like Oceania, or worldwide? Does the seller plan to expand the area of service, or combine it into an existing business that covers a larger area? Is it fair?
Industry: A bug-bear we have is when a buyer attempts to include ‘a similar business’ without defining what that is, or to include the businesses operated by a group of companies related to the buyer, whether or not those businesses are in the same industry or something completely different. Restraints should focus on the business being sold, not something broader.
People: It makes sense to restrain a seller from working with existing or potential customers already known in the business being sold, however, we have assisted sellers in being permitted to retain a client list for the purpose of communicating a new business, where that business does not compete with or adversely affect the buyer.
Key contacts: It can be also worthwhile include a restraint against poaching staff, suppliers or distributors for a period of time after completion.
Time: Periods of restraint can vary significantly, anywhere from months to years. Times and areas of restraint vary depending on the type of business and the reach of that business. It is also common to have cascading provisions, which leave it to a court to decide what is fair if a restraint is breached. We encourage our clients to consider the period of time it would take a knowledgeable competitor to set up a similar business, and to be reasonable in setting the time for restraint. Where a large infrastructure investment is likely to be threated by competition from the seller, then a longer restraint period is likely to be considered fair and reasonable.

7. The Limits of Each Adviser

It’s tempting to think that your advisers will have all the answers when you are buying a business and be able to tell you what to do if you end up in a situation where you feel a little lost. This can happen for people who have never bought a business before.

As legal advisers, we can review the contracts and check that the contracts properly describe what you think you are buying and what your obligations, and the obligations of the seller will be, after purchase. We can highlight potential rights and flag decisions you must make – but we cannot make those decisions for you.

The truth is, it is your responsibility.

Your accountant, lender or financial adviser are all in the same boat. They can highlight information for you, but they cannot make the decision whether or not to buy, and they cannot determine how much importance you place on any piece of information.

Case Study 7

Many years ago when working in a national firm, a client who had borrowed significantly (millions) to fund a purchase was part way through the due diligence process and wondering whether or not the purchase was going to be worthwhile. It got to a point where the client was saying “we’ve spent too much (around $300k) now not to go ahead.”

There was an element of wilful blindness on the part of the purchaser in that transaction. They had put their reputation, and their house, on the line to fund a purchase that was looking more and more questionable the more they learnt about the business. Going through with the purchase was more about their ego and being ‘clever’ at getting the deal done.

About 6 months after settlement, the business failed and was placed into liquidation and the director was forced into bankruptcy.

It is your money. It could be your reputation, your family and your future that you are staking on this purchase. As much as professional advisers can provide you with advice, advisers cannot tell you what to do and all the important decisions are up to you. This makes it important to be up front with your advisers, whether legal, financial, accounting or otherwise, and ensure they understand your priorities and concerns.

A binding contract requires offer, acceptance and consideration. Consideration can be the doing of some thing or the payment of money.

At every point before consideration has passed, you are likely to have the opportunity to exit from a transaction, no matter how much has been spent getting to that point. Sometimes, a small loss can be better than taking a risk that doesn’t feel right.

When you are buying a business, you will also have a period of time to complete due diligence and should use that time to ensure that your assumptions about the business are correct, and if not, whether you still want to go ahead, negotiate further, or walk away.

As we said at the start – don’t rush in.

How can Onyx Legal help you?

If you are interested in buying a business, whether this is your first time or your tenth, and you know you need help in the process, make an appointment now to talk it through with one of our team.

Make an Appointment

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