However, there are important points that any founder should consider when it comes to personal relationships - in particular, marriage and civil partnerships - as founders, investors and others associated with a start-up can be severely impacted if a marriage or civil partnership breaks down.

Shares in any start-up held during a marriage or civil partnership are treated in the same way as other assets on divorce or dissolution; along with real property, bank accounts, investments, chattels and pension funds, business interests are included in the schedule of assets, ascribed a value (wherever possible) and taken into account by family lawyers and the family court when looking at the financial resources available to the parties, and how the resources should be divided to achieve a ‘fair’ financial settlement in all the circumstances of their case.

There is no set formula for the family court when it deals with shares in a business on divorce or dissolution. Each case turns on its own facts, and whilst in most cases one spouse/civil partner will retain their shares, and the other spouse/civil partner will be awarded a lump sum, a deferred lump sum (which may or may not be supported by a legal charge over shares), maintenance payments or a combination of lump sums and maintenance, as the court strives to achieve a separation and independence for the parties rather than tie them together - in cases where:
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(a)     the shares are a valuable asset;

(b)     the value represents a large part, or the majority, of the value available for division between the parties, and the other spouse/civil partner cannot be compensated by other assets;

(c)      there is a dispute about valuation of the shares and future liquidity, which cannot be resolved satisfactorily; and/or

(d)     for other reasons it is necessary to make an order in respect of the shares to achieve a fair settlement and do justice between the parties,

the family court can order that a portion of the shares be transferred to the other spouse/civil partner or sold.

The consequences of a transfer of a founder’s shares to a non-founding former spouse/civil partner are usually unanticipated and can be highly detrimental to those concerned with the business. A share transfer may result in the former spouse/civil partner obtaining voting, veto or other rights which allow him or her to disrupt, and interfere in, the business, and impair its governance and growth. A transfer of shares can also cause friction with any co-founder who is forced to work, and share profits, with a new, undesired, and possibly hostile partner who has acquired substantive rights.

Furthermore, a share transfer could breach agreements that the founder and/or the business has with investors, lenders, suppliers or distributors and others regarding changes in ownership. For example, founders may agree amongst themselves and with investors that they will not transfer all or part of their shareholding before it vests and satisfies other specified requirements, and an order by the family court for a transfer of shares could give rise to a contractual breach.

An order by the family court which results in a founder having to sell their shares in a business, or the business itself, to satisfy a financial award for their spouse/civil partner could spell disaster for all concerned.

Any founder should, therefore, consider the risks that divorce/dissolution poses to them personally, to all those associated with the business and to the business itself, and take steps to mitigate those risks and provide comfort, wherever possible. Founders may be willing to take the risk, but investors and venture capital firms may not be. Investors may want reassurance that the business will not be impeded, disrupted or devalued by the breakdown of a marriage or civil partnership.

In addition to customised Articles of Association, a Founders Agreement, Shareholders Agreement and Nuptial/Civil Partnership Agreements should be viewed as essential legal documents to ensure the smooth running, success and preservation of a start-up.

Founders Agreement

A Founders Agreement is typically created on the formation of a start-up. It is a legal contract that governs the business relationship between the founders and details their respective roles, rights, responsibilities and obligations to each other, and to the business. It should provide mechanisms for decision making and the resolution of disputes between founders, and contain restrictions on share transfers, vesting and exit arrangements.

Shareholders Agreement

A Shareholders Agreement is a comprehensive legal contract that tends to be created once the start-up has been incorporated and shares are to be issued to third party investors. Whilst there can be overlap between a Founders Agreement and a Shareholders Agreement, a Shareholders Agreement governs the relationship between the shareholders and can replace a Founders Agreement.

A Shareholders Agreement should provide mechanisms for decision making and conflict resolution, and again contain restrictions on share transfers, vesting and exit arrangements.

Share transfer restrictions prohibit a shareholder from selling or transferring shares to a third party, other than in specified circumstances, and typically include the prior consent of other shareholders, a right of first refusal by other shareholders, drag-along and tag-along rights.

However, Founders and Shareholders Agreements may also contain back-up clauses that remove voting rights from shares transferred to a former spouse or civil partner pursuant to divorce or dissolution and provide for the interest they acquire in the business to be financial only, unless otherwise agreed by the other founders or shareholders.

If it is not possible to remove voting rights from shares transferred to a former spouse or civil partner, such agreements may include a provision giving other founders and shareholders the option to buy-out the former spouse or civil partner’s interest in the business. The agreements may detail the process for a buy-out, the time for completing each step of the process, the means of valuing the interest for the buy-out and the method for payment to the former spouse or civil partner.

Restrictions within corporate documentation that give rise to concerns about the implementation and enforcement of share transfer or sale orders may deter the family court from making such orders on divorce or dissolution, but they do not stop the court ordering a transfer or sale of shares.

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Nuptial and Civil Partnership Agreements

Further key documents to be considered for a start-up are, therefore, nuptial and civil partnership agreements*.

A founder should consider the additional protection that can be afforded by them having a personal legal agreement with their spouse or civil partner. They may also require co-founders and future investors to have personal legal agreements with their spouses or civil partners, as a condition of launching the start-up and securing investment.

A pre-nuptial agreement is a legal agreement made between two individuals before they marry.

A post-nuptial agreement is a legal agreement made between spouses after they marry.

A pre-civil partnership agreement is a legal agreement made between two individuals before they register their civil partnership.

A post-civil partnership agreement is a legal agreement made between civil partners after their civil partnership is registered.

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These agreements usually set out how the spouses/civil partners wish to divide their assets and liabilities, and deal with income, if their relationship should breakdown and end in divorce/dissolution.

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Nuptial and civil partnership agreements can also set out how shares in a business are to be treated on divorce or dissolution. Founders and shareholders can agree to deal with business interests separately from other assets, or specify that certain business interests, or the value thereof, will be shared with their spouse or civil partner.

Whilst nuptial and civil partnership agreements should ideally dovetail with the corporate documents for any start-up, such agreements are viewed, and operate completely independently of, the corporate documents. As such, they can protect a business and all those associated with the business irrespective of the existence of, or any omission in, a Founders Agreement or Shareholders Agreement.

The benefits of founders and investors entering into nuptial and civil partnership agreements can be summarised as follows:

(i)       The agreement may provide for their shares in the business to be treated as ‘separate property’, ringfenced and retained by them as part of the division of the assets and liabilities on divorce or dissolution. This should allow the founder or investor to maintain control of their shares, prevent disruption to the business throughout the divorce or dissolution process and ensure that they retain the full current, and full potential future, value of the shares.

(ii)      If it is not considered fair in all the circumstances for the entirety of their shares to be treated as ‘separate property’, the agreement may record the pre-marital or pre-civil partnership value of their shares and provide for this to be treated as their ‘separate property’. What element of a business constitutes pre-marital or pre-civil partnership property is not entirely clear in law, but this can be clearly defined in an agreement.

(iii)    Alternatively, if the founder’s spouse or civil partner is a co-founder or shareholder, who may or may not work in the business, they can agree how their respective shares will be divided on divorce or dissolution, and the mechanism for any transfer, buy-out or buy-back. They can also agree other arrangements for their spouse or civil partner’s exit from the business, and for the division of all other business and non-business assets.

(iv)    If it is considered fair for their spouse or civil partner to share the current and/or future value of their shares on divorce or dissolution, the agreement can detail how the shares are to be valued at the relevant time, and how the ascribed value is to be shared. It may be agreed that the spouse or civil partner should receive up to 50% of the net value of the shares, or significantly less than this if the start-up was formed prior to their relationship and/or they are to receive a greater share of the non-business assets. An agreement about how shares are to be valued on divorce or dissolution can avoid disruption and save a huge amount of time and expense obtaining a third party (usually a single joint expert) valuation, which can inconvenience founders, employees, accountants and others associated with the business, and involve a forensic review of records and procedures and an analysis of future prospects.

(v)     Again, if it is considered fair for their spouse or civil partner to share the current and/or future value of their shares on divorce or dissolution, the agreement may detail how the founder or investor is to account to their spouse or civil partner for their share of the value. This could be by a lump sum, payable forthwith or by a specified date in the future (having regard to liquidity and what assets may be extracted from the business to pay the lump sum), or a deferred lump sum calculated as a percentage of the net sale proceeds and payable upon completion of a future sale of the shares. Either way, the spouse or civil partner will not acquire any shares in the business.

(vi)    The agreement should seek to mitigate the future tax consequences of dividing all assets and liabilities on divorce and dissolution.  

(vii)  The agreement should include a confidentiality clause, to ensure that a spouse or civil partner who is privy to private information about the business is not at liberty to divulge this, or details of the financial settlement, to third parties.

(viii)  The agreement may also include a non-compete clause, prohibiting a spouse or civil partner from subsequently founding their own start-up or otherwise competing with the business.

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(ix)   The agreement can record how the parties agree to bequeath their shares in any business on death, and support the provision contained in any will.

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*  As the law currently stands, nuptial and civil partnership agreements are not ‘legally binding’ or ‘enforceable’ in England and Wales. However, such agreements are considered by the family court as part of all the circumstances of the case in determining financial claims pursuant to divorce and dissolution, and they now carry ‘decisive weight’ providing they are freely entered into by the parties, with a full appreciation of the implications, and they are fundamentally fair.

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The family team at Sheridans deals with nuptial and civil partnership agreements for all clients, including founders and investors, and the firm’s corporate and venture capital teams have a wealth of experience in the formation and development of start-ups and other businesses.

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For any query or further information on the matters covered in this insight, please contact family@sheridans.co.uk.