When a business started by two people is incorporated into a company, the founders often split the shares 50:50 because it seems “fair” to do so. At an early stage in the life of the business both founders may have contributed to it equally in terms of equity investment, and are unlikely to have spent a lot of time working for it. Both share the same vision to build the company and both are optimistic for the future.
However, 50:50 ownership of a company is fraught with difficulties. If the question was asked “How should we split ownership of our company?”, the answer would be “Any way but equally.”
The reason boils down to ultimate control. In situations where one founder disagrees with the other (perhaps about making an investment in a new piece of machinery, or about selling shares to a business angel), deadlock will occur. There is a saying “any decision is better than indecision”. That applies here. If the owners of the business cannot agree on what the business will do, the business will suffer. If that happens, both founders will suffer as the value of the business declines.
There are ways of resolving shareholder deadlock, but they aren’t particularly good options if the business is to be kept going.
Appointing an outsider to have a casting vote is also often suggested. For example, that might be someone with great experience in the industry who is appointed as a non-executive director of the company. This isn’t a bad option for resolving board level deadlock. However, shareholders are not legally bound to any third party’s views.
Under company law, certain decisions can only be made by shareholders who hold over 50% of the shares. Shareholders with 51% of the equity have the power to appoint and remove directors (and thus change day to day control) and to approve payment of a final dividend. Additionally, if your co-shareholder has over 25% of the shares, he may block any special resolution, such as one to change the articles of association of the company. In summary, if you want full control, you need over 50% of the shares and your fellow shareholders should have under 25% (either individually, or better still, between them).
There are often ways of achieving the same goals as 50:50 intends without owning the shares equally.
The first is to use different classes of shares. Different rights can be given to different classes. For example, preference shares usually have no voting rights, but the right to receive dividends before dividends are paid to ordinary share holders.
The second is to specify in the shareholders agreement which shareholder has rights to vote on certain matters. For example, you could agree that you co-founder has no rights regarding payment of dividends until your loan to the company has been repaid. There are some matters that can’t be changed by using a shareholder agreement, but it is a good option.
The best and simplest alternative is for one of the founders to own slightly more of the company than the other. If one of you has invested debt into the company, or came up with the original idea, the other may be open to accepting a minority position. It will certainly save a lot of headaches further down the line.