Setting Up a Business - 8 Most Common Mistakes

Starting a new business is an exciting, busy and challenging time. But amid everything else you have to do,  it is all too easy to overlook some essential details which, if put in place at the early stages, will strengthen your business and can save time and money in the future, as easily preventable problems are avoided.

FWJ can help you avoid some common pitfalls and give your new business the best possible. start.

Contact us if you need help answering any of the following:

1. Am I choosing the wrong trading entity?

After deciding the nature of your business, perhaps the most fundamental decision (and one that it is easy to overlook in the rush to start trading) is type of entity you wish to use. You can run a business:

(a) As a sole trader: there is no formality to your business structure; you just set up and carry out your business independently.

(b) In partnership with one or more other people: a partnership will arise where two or more people are in business together with a view to making a profit. This can be an informal (or even unintended) relationship or properly documented by a partnership agreement or by using the limited liability partnership structure.

(c) Through a limited company: this is the most formal business structure, but it is quick and easy to set up a company through which you run your business.

FWJ can offer advice on which is the right business structure for your particular needs, one that takes into account your personal situation, e.g.: income and tax, assets and risk, management and control.

2. Am I taking on too much personal risk?

In today’s economic climate the issue of risk can never be far from the business owner’s) mind. Having decided to take the plunge, do not forget the potential impact of running your own business on you personally. The level of personal risk, including the risk to your personal or your family’s assets that you assume when running your own business can be directly affected by the business structure you have adopted.

The best way to separate your (and your family’s) assets from the obligations of the business will be to run your business through a limited liability company, which has its own legal personality and owns the assets of the company itself. As a shareholder of a company your liability (as the name implies) is limited to the value of your shareholding. However as a director, you will have numerous duties to comply with [see “Roles and Responsibilities of Directors”], some of which, if breached, could have serious consequences for you. You may need to evaluate the relative merits and drawbacks of being a company shareholder and/ or director.

As a partner or a sole trader the assets of the business are owned by you as an individual and you are fully liable for the debts of the business.  For this reason, these can be more risky business structures, but they may give you more flexibility and independence in running the business.

It is all too easy in the rush to get the business off the ground to overlook the question of who owns the assets and is responsible for the liabilities of the business. Don’t leave yourself exposed to unacceptable risks and make sure you understand your potential obligations.

FWJ can help with advice on how to minimise your exposure to risk.

3. Do I Understand what I have agreed with my business colleagues?

Unless you are running your business alone and funding it from your own resources, it is likely that you are setting up the business with friends, relations or a professional investor who specialises in providing capital for new or developing businesses. Whilst everyone is focusing on the start up and you are all caught up with the excitement of the new enterprise, it can seem obstructive or even over-pessimistic to insist on formal documentation to govern your relationship, such as a partnership or shareholders agreement. This common mistake can be one much regretted later on, if there is no record of financial contributions to be made, distribution of rewards, allocation of decision making powers or provisions for separating interests when circumstances change.

We would always recommend an agreement is drawn up between everyone involved in the business to regulate the management of the business

A professional investor will not overlook the need for an investment agreement, but do make sure you understand the terms and do not, in the rush to receive the crucial capital, sign anything you are not happy with. Points to look out for include: investor rights to appoint directors who may have the key influence over the business or terms which require repayment of the investment or sale of the business at the investor’s demand.

We can assist you in this very important area.

4. Have I chosen the right type of funding?

Funding for businesses can take a variety of different forms from a range of finance providers. To the inexperienced this can be baffling and, if the wrong selection is made, expensive. Do you need:-

·         A capital investment to get started?

·         A bank loan to buy a key asset?

·         A bank overdraft to smooth you through the trading cycle?

·         Cash-flow finance?

FWJ’s extensive network of brokers and long standing relationships with specialist financiers can help you find the right type of funding for your business. Once you have decided, we can guide you through the finance and any related security documents and ensure you sign the best deal for your business.

5. Do I have proper credit control procedures in place?

Getting paid for the work you do on time, or even at all, is one of the single biggest challenges for any business. Your customers may seek to improve their own cash flow position by leaving your bills unpaid whilst your own creditors put you under pressure to pay them before you have the funds, leaving you stretched and stressed. Not collecting your invoices promptly can cripple your business’s cashflow and so it is vital that you do not overlook the paperwork until it is too late. 

Some financiers offer facilities which can incorporate a full credit management service which might meet your needs and we would be happy to introduce you to someone who can help.

At FWJ we also have a team which specialises in debt recovery work and can help advise you on your credit control and recovery procedures together with taking action to collect money from slow payers.

6. Am I up to date with my record keeping?

Unless you are an office services provider it is unlikely you have set up your own business because you like filing and completing forms.  However a business can soon run into problems if the statutory obligations, such as tax and VAT returns (and payments) are not made, accounts not prepared or company registration formalities are not kept up to date. At their most extreme, these omissions can bring your business to an untimely end with some potentially serious consequences for you, even if you are making money.

Through our long standing connections with accountants and tax advisors, we can introduce to you the right person to handle your tax affairs. If your arrears are such that HMRC has issued a winding up petition against your company or you are facing bankruptcy proceedings, FWJ can put you in touch with insolvency practitioners and business turnaround specialists who can advise you on how to proceed. We can also help if you company has been dissolved by Companies House for the non-filing of statutory returns whilst you are still active.

If you a company director where the record keeping is found to be so poor that steps are being taken to disqualify you from acting as a director or being involved in any other way in the management of any business in future, speak to FWJ’s experienced Director Disqualification  team who can help you improve your position.

7. Are there any terms of business?

One of the most common oversights we see, usually when trying to resolve a dispute, is the complete lack of any terms of business. Every time you perform a service or supply goods to a customer, you need to specify the terms on which you are acting: what are the goods or services required, what quantity, when, what price, where? There are many other questions: when are you to be paid, can the goods or payment be refused, what other liabilities are attached, is the work warranted?

You can make great savings of both time and money by investing in the preparation of standard terms and conditions on which you then conduct your business; make sure you have terms that meet your needs rather than find you have inadvertently agreed to operate on someone else’s terms (which are not to your advantage) or that there is no formal agreement and you find yourself embroiled in protracted (and expensive) correspondence or even litigation to protect your business.

We can draft these for you.

8. Have I sorted out our premises and employees?

There are many hidden pitfalls relating to the premises you operate from and your responsibilities towards anyone who works with you. Falling into any of these traps could cause unexpected problems for your business, for example:

Premises:

·     If you plan to work from home, do the terms of your lease or mortgage prohibit the use of the property for a business? Are you covered for liability to any visitors to the premises in connection with the business?

·     If you are leasing premises, do they have the necessary user authorisations, do they meet all relevant health and safety and environmental regulations? Are there any restrictions in the terms of the lease that may inhibit the conduct of your business? What are your obligations as a tenant?

             Employees:

·     If you intend that anyone working with you is “self-employed”, be aware that the courts will imply a contract of employment unless the strict criteria for self employment are met, bringing with them additional responsibilities for you, including payment of tax and national insurance for employees.

·     If the company’s directors are working in the business, are they also employees? Do you have service contracts in place?

If you would like our help in making a successful start and avoiding these common mistakes, please contact us.   And we wish you good luck in your new venture.

Successful claimant ordered to pay majority of defendant's costs

Getting costs right.

In the words of Coulson J in the recent case of Brit Inns Ltd and another v BDW Trading Ltd (No 2) [2012] EWHC 2489(TCC) “when civil litigation goes wrong, costs become the critical issue”. 

The case concerns two separate actions, a subrogated insurers’ claim whereby the insurers were able to step into the shoes of their client/ the claimant and retain any benefits or remedies awarded to it and a distinct uninsured claim by the Claimant directly. 

In its subrogated action the Claimant had made two Part 36 offers, which were held to be unrealistic and unreasonable as to costs under CPR44.3.  Conversely, the Defendant made one Part 36 offer, which, although it failed to improve upon the offer at trial, was held to be more realistic and reflected the relevant conduct for the purposes of CPR44.3. Subsequently the Claimant went on to be successful at trial and, although in keeping with the general rule of CPR44.3, Coulson J ordered the Defendant to pay 60% of the Claimant’s reasonable and proportionate costs. The significant reduction of 40% was a result of the Claimant’s failure to adopt the same detailed approach as the Defendant, which could have resulted in settlement at a much earlier stage.

More notably, in respect of the uninsured claim, the Claimant was ordered to pay 90% of the Defendant’s costs primarily owing to the Claimant’s decision to have two separate actions and two separate legal teams inevitably duplicating costs and it was this decision that was held to be unreasonable in respect of costs. 

In reaching these conclusions, Coulson J provides us with a useful summary of relevant principles when dealing with costs where the claim is exaggerated and the Defendant has been unable to make an effective Part 36 offer.  This case undoubtedly serves as a reminder to parties to take a much more realistic and cooperative view of the value of a claim when faced with the harsh realities of recovery and costs in litigation.

For advice or further comment on the above, please contact Partner Andy Wilks on 020 7841 0390.

Common FAQs for Shareholders and Directors

How do Shareholders’ and Directors’ roles differ?

A company is an independent legal entity separate from its Directors and Shareholders.

A Director of a company is responsible for directing its affairs on a day-to-day basis, promoting its success and protecting all stakeholders (i.e. Shareholders, employees, the company itself and, in certain circumstances, creditors).  

The Shareholders of the company have an interest in the equity (i.e. the net value of its assets), which they own in accordance with the shares allocated to them.  They have certain powers under the relevant legislation in terms of how their decisions (referred to as “resolutions”) are reached, how the structure of the company is managed (including its funding and Directors’ appointment) and how they can deal with company assets (e.g. payments to Directors).  The Shareholders otherwise have no role in managing the company or determining its direction, other than as determined in the company’s constitution (i.e. the Memorandum and Articles of Association), any Shareholder’s agreement and by way of resolutions passed at general meetings of Shareholders.

Directors must call an Annual General Meeting of Shareholders (“AGM”) but there is also an ability for Shareholders, of the requisite number, to request a meeting outside of these time limits during the year – this is called an Extraordinary General Meeting (“EGM”). Shareholders’ decisions are normally reached by reference to the Shareholders present (or voting by a nominated proxy, usually the chairman) voting on specific decisions and such decisions are passed either by an Ordinary Resolution (requiring 50%) or a Special resolution (requiring 75%).

What happens if Directors or Shareholders disagree on a decision?

The Company’s Articles of Association and/or Shareholders’ Agreement sets out the rules as to how company decisions can be taken and what Directors can do as part of their day-to-day governance of the company’s affairs.  

Beyond the day-to-day decisions, the majority of decisions made by a company (e.g. the removal of a Director and the approval of “conflict” situations) require a simple majority (i.e. 50.01%) of Shareholders present at a general meeting to agree to pass an “Ordinary Resolution”.  

In the event that a Director or Shareholder disagrees with a decision made at a general meeting, it is first necessary to consider whether correct notice of the meeting was provided, all other formalities complied with and whether the appropriate Shareholder Resolution was passed to validate the decision being complained of.  In the event that this is not the case then the decision (i.e. the Resolution) may be invalid and the decision will not stand.  The status quo will therefore continue until a valid Resolution is passed and a decision made. This can raise difficulties in practice and specific advice should be sought on the relevant facts.

How can a Director be removed from a company?

The most important point to note is that the removal of a Director requires Shareholder support (save a decision to demote a Managing Director to Director).  At a general meeting, Shareholder support of in excess of 50% (i.e. an Ordinary Resolution) is normally required for a decision to be taken to remove a Director from a company (unless varied by the Shareholder Agreement or Articles of Association).  It should be noted that 28 days notice (referred to as “Special Notice”) must be given to the Director of the resolution to remove him/her and, in the event that sufficient notice is not provided, the resolution to remove the Director will be invalid.  Upon receipt of notice, the Director is entitled to distribute to Shareholders his/her written representations contesting his/her removal as a Director.  The Director is also entitled to make verbal representations at the general meeting itself (note that an actual meeting is required and that the resolution to remove a Director cannot be passed by way of written resolution in lieu of a meeting).  Following representations in defence of his/her position, the Director will or will not be removed depending on whether the requisite majority of Shareholder votes is cast in favour of the Resolution to remove the Director.

What are a Director’s fiduciary responsibilities?

Directors have a number of legal responsibilities and duties to the company, primarily stemming from a general duty to act in good faith in the best interests of the company.  More specifically, Directors are required to act within the powers conferred upon them by the company’s Articles of Association; they must promote the success of the company and exercise reasonable skill and care and diligence in their particular area of management; they must avoid conflicts of interest (save those declared and approved at a general meeting) and they must not accept personal benefits from third parties without authorisation at general meeting (subject to any alternate provisions within the Articles of Association).

How to resolve a “deadlock” situation?

A deadlock situation commonly occurs in small or medium-sized businesses under the control of only a few Directors and/or Shareholders.  

Occasionally, the Directors may have a disagreement on certain decisions and, as a result, the board is split 50:50 and the decision is “deadlocked”.  It is not uncommon to have a provision in the company’s Articles of Association to provide for this situation and provide a casting voting to one of the Directors (usually the chairperson) or alternatively to provide for a third party to intervene.  If there is no such provision then the board is deadlocked and this will prevent the decision being decided upon.

In such a situation, the Directors should then turn to the Shareholders who have wider powers to terminate a Director’s appointment or pass Resolutions on specifically addressed matters.  However, especially with a small business, an identical situation can occur where the same individuals are both Shareholders and Directors with no other parties involved.  A deadlock situation therefore continues.

The solution to a Shareholder deadlock will again be dependent on the company’s Articles of Association and any Shareholder agreement.  If there is no provision to deal with this deadlock and no alternative provision for (e.g.) formal mediation, then the parties must look to negotiation to resolve the problem or, ultimately, their legal options. 

If the Shareholders must resort to a legal route to settle the dispute or recover their interests (sometimes as a minority shareholder – see below) then the available options include seeking to wind-up the company, issuing a petition against a Director for unfairly prejudicing a Shareholder right or seeking a derivative claim on behalf of the company (derivative meaning that the authority derives from your equitable interest in the company). 

What rights do I have as a minority shareholder?

Any shareholder with at least 5% shareholding can, subject to a company’s Articles, require the board to call a general meeting of Shareholders and to propose a Resolution for consideration by the Shareholders at a general meeting.  The decision, whether requiring an Ordinary or Special Resolution, will or will not be passed according to shareholder support.

In the event that a minority shareholder’s rights are being breached, they are entitled in the appropriate circumstances to apply to the Court for an Order stipulating that the Company has acted or continues to act unfairly (Section 994 of the Companies Act 2006).  Such a Petition is commonly referred to as an “Unfair Prejudice Petition”.  Dependent upon the facts, such a Petition, if successful, may give rise to an order giving such relief as necessary in respect of the matters complained of.  This includes orders made to regulate the company’s affairs, require the company to do or refrain from doing the action(s) complained of, authorise proceedings to be issued on behalf of the company, direct alterations to the company’s Articles of Association or provide for the purchase of shares by other Shareholders.

Where appropriate, minority Shareholders can also apply to the Courts for a company to be wound-up upon the grounds that it is just an equitable to do so (Section 122 of the Insolvency Act 1986).  Such a Petition can lead to the company being wound-up in the event that no alternative solution exists, including the purchase by the company of the petitioning Shareholder’s shareholding.  However, great caution needs to be taken in such matters as the Court is hesitant to allow minority Shareholders to disrupt a company’s business in contravention of the majority’s rights and so will only consider this an option of last resort.

Legal action can be taken against the Directors personally in respect of negligence/breach of a Director’s fiduciary duty by way of a derivative action (i.e. an application issued in the name of the company itself) against a Director personally.  Such an action can result in the Director being forced to compensate the Shareholder or the company or, if merited, the Director’s removal as Director.  

As a general note, other than as described above, minority Shareholders have a limited entitlement to affect the company process through day-to-day communication with Directors and/or Shareholders (especially in smaller businesses with common Directors and Shareholders) and to criminal redress through the police or the use of a mediation service, where applicable. 

For advice or further comment on the above, please contact Partner Andy Wilks on 020 7841 -390.