LAWYER Q&A

March 27, 2018

“I’m thinking of investing in a start-up. What steps should I take to protect my investment?”

 

Investing in a new business venture always involves a lot of uncertainty. Protecting your investment can be difficult, but there are a handful of basic steps you can take to reduce the risk of doing your dough.
Firstly, if you’re buying into an existing enterprise, make sure you take the time needed to do your due diligence. If a corporate body is involved, the starting point is to get a copy of the company's constitution, to work out how decisions are made and who makes them. You’ll need to get your head firmly around the track record of both the business and its key personnel, and the best way to do that is to make sure you get access to all of the financial records, and undertake basic ASIC and NPII searches. You need to ascertain precisely who and what you're dealing with, who really owns what, and whether those in control have a squeaky clean track record. Work out what the major assets of the business are (where the value lies), how they’re secured, where your cash injection is intended to end up, and how your shares in the business are to be valued.
Once you’ve made the decision to invest, either in a new or existing business, an effective shareholder’s agreement is imperative to protect your investment. Companies aren’t required under law to have a shareholder’s agreement, but it's highly preferable to have one if you want to maintain some control over how the business will evolve.
A shareholders’ agreement will generally set out the ground rules relating to various issues which will affect you as an owner – where will future funding come from? – what are the rules if a shareholder suddenly wants out? – how will disputes be resolved? – what direction will the company take, and what are your rights as a shareholder moving forward? All of these questions are fundamentally important issues, and at some stage during the operation of the business, they'll all likely come to the forefront for you and your business associates. Shareholders’ agreements are essentially a blueprint to deal with any issues which may potentially arise during the life of the business. All too often directors with a grievance seek to change things, only to find they’re essentially lame ducks with no control of the decision-making in their own business, which is being pushed forward entirely without their input. In the absence of a proper shareholder’s agreement, business owners are often prevented from asserting any influence over the direction the enterprise takes, and how its earnings are disbursed.  
Of course, when people jump into a new business venture they’re so focused on getting things up and running, and the excitement of what the future may bring, they’re sometimes guilty of overlooking the prospect that things could eventually turn foul. In reality, every business will almost certainly evolve over time. Close business partners can grow apart, their aspirations may change, and some day they may want different things from their investment. It’s important to have a legal framework in place at the outset to cope with all those very likely eventualities. Otherwise, differences of opinion which often give rise to disputes have the potential to cripple your business down the line, and see you fall victim to the startup casualty list.
As always, the old golden rule applies – hope for the best, but plan for the worst.

Brendan Nyst, Director and Dispute Resolution Lawyer, Nyst Legal, www.nystlegal.com.au

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