Forming a Business Together? Sign a Prenup

A prenuptial agreement (prenup) is a contract made between two people before marrying that establishes rights to property and support in the event of divorce or death. Hollywood actor Tom Cruise, who infamously jumped on Oprah Winfrey’s couch in delirious joy while describing his love for his soon-to-be third wife Katie Holmes, signed a prenuptial agreement with the blushing bride before their marriage in 2006. Katie was to receive $3 million dollars for every year of marriage. One week past their five year anniversary, Katie filed for divorce and amicably walked away with $15 million. Meanwhile Tom Cruise’s second wife Nicole Kidman married country singer Keith Urban in the same year 2006. The Hollywood actress who is reportedly worth $250 million put in a clause in the prenup to protect herself from Urban’s apparent struggles with drug and alcohol. In the event of divorce, Urban would earn $600,000 for every year of marriage but only if he kept his drug addiction under control. According to Rolling Stone magazine, Urban checked himself into a rehabilitation centre months after their wedding and has remained sober since.

In 2017 when the Kenyan Companies Registry went digital and provided online registration for companies, a few lawyers were up in arms, chomping at the bit and frothing at the mouth in a rabid frenzy. The reason for their angst: ordinary wananchi could now register their own companies following clearly articulated steps. The simplified process gave access to anyone who had the patience to navigate an online system a way to submit documentation without the need to read the almost  3 kilogram tome that is the Kenyan Companies Act. Yet the need for a lawyer has never diminished in company related matters, as the formation of a company between two individuals still requires a prenuptial arrangement.

Just like the onset of any marriage, individuals who come together to do business are crazy in love with the idea of joining forces to start off a commercial venture that is anticipated to succeed.  The idea of creating mad profits together is the tantalizing outcome of the business consummation, just like children are the natural outcome of a marriage consummation. It is all peaches and cream between business (and marriage) partners, until it is not. A shareholder’s agreement is the business equivalent of a prenup. A marriage prenup is a post mortem arrangement, envisaging that the marriage will come to an end and providing clarity on how that institution will be buried in dignity with all parties walking away from the cemetery happy. The shareholder’s agreement on the other hand governs how parties will engage during the lifetime of the business. It can cover voting requirements for major decisions like borrowing, dividend distribution or big capital expenditure spend or even how board seats will be allocated according to shareholding. The shareholder’s agreement envisages that the business will remain a going concern and that if one party wishes to realize the value that the company has created by selling their shares, a methodology for selling all or part of that value is defined without killing the goose laying the golden egg as it were.

Clauses such as “first right of refusal” can be put in the shareholder’s agreement so that the original shareholders get a bite of the cherry first and protect them from being forced into a business marriage with a partner not of their choosing. Defining how such an exit will occur is absolutely critical because the last thing shareholders want is to destroy a business that has a wide number of stakeholders such as employees, customers and suppliers all in the name of separation. A key issue that always emerges at the point of voluntary separation is how to value the shareholding. The shareholder’s agreement should therefore provide a mechanism for what methodologies of valuation will be used thus ensuring that there is fairness to all sides. This is better done at the honeymoon stage of the business marriage rather than at the “nil-by-mouth sleeping in separate bedrooms” stage.

Furthermore, the agreement should envisage what would happen in the event the majority shareholder wishes to exit after being wooed by an attractive investor who is really not feeling the vibe of the minority shareholder. “Drag along”” clauses are a useful way of protecting the majority shareholder from a petulant minority shareholder while “tag along” clauses protect the minority shareholder from being left at the mitumba pricing lights. For more details on this, dial star “next Monday on the Nitpicker” hash.

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Twitter: @carolmusyoka

 

 

 

Echo Chamber in the Family Business

An echo chamber is defined as an environment in which a person encounters only beliefs or opinions that coincide with their own, so that their existing views are reinforced and alternative ideas are not considered.. You must have seen one of those in your work team meetings when the leader is talking with everyone nodding their head furiously at whatever he says and laughing uproariously when he cracks stale jokes about his mother in law. Or maybe you’ve seen it in your family meetings, where a feared matriarch speaks. No one dares to contradict her edicts or opinions because doing so will destabilize the way things are done around here. Peace must be maintained. Even if she’s potentially leading everyone over a cliff into a deep abyss.

The danger of echo chambers is that without differing or dissenting opinions, the occupants of the chamber may fail to see potential danger in the horizon. Talent attrition brushed off as “anyway those guys were useless”, shifts in consumer tastes attributed to “those goods are cheap, our customers will be back” or worse still, family members who are suffering from mental health issues are labelled “just being spoilt”. These are some examples of blind spots that need to be called out by a brave, dissenting voice.

 

I have been getting a lot of queries recently from entrepreneurs curious about what a board can do for them. Let me start with a basic premise: you do not need to set up a statutory board which is where you appoint directors via the provisions of the Companies Act and have to register them at the Registrar of Companies. You can start the gentler way, which is to set up an advisory board. This is a group of experienced people who have no legal affiliation to your company but who come together to sense check your strategy, your risk framework, your financial performance or your product proposition. They can do all of that or some of that. It’s entirely up to you, the business owner, to define what advice you want from them.

It’s also entirely up to you to determine how many times you want them to meet in a year, what information you want to share with them and what renumeration, if any, you want to pay them. But let me warn you that if you want to get talented individuals who don’t want to feel that their time is being wasted, be prepared to open up your operations for scrutiny, your financials for a thorough review and your strategy for an intensely deep interrogation. You can create professional boundaries by ensuring you have a board charter that outlines what the role and the responsibilities of these advisory directors will be. Included in the board charter can be a non-compete clause which clearly states that an advisory director cannot enter into the same business line as yours, and if she does then this would be grounds for termination of the appointment. You should also include confidentiality clauses to ensure that the information shared remains within the business confines and is not the subject matter of a discussion at a nineteenth hole somewhere on a Limuru golf course. The same should be replicated in an advisory director appointment letter which states the tenure of the directorship, let’s say three years, that may be renewed. It should also state the remuneration (if you want monkeys throw peanuts, so get serious about what you want to give as a sitting allowance) as well as have confidentiality and non-compete clauses, the latter of which should be grounds for termination if breached.

Bats send out ultrasound waves and use their echoes to identify the locations of objects that they can’t see. Which is why the euphemism “Blind as a bat” is quite oxymoronic because though blind, those critters fly around quite efficiently. Your advisory board of directors will be your bats, to help you turn your business echo chamber on its head, helping you identify the potential stumbling blocks that you cannot see: Staff talent that needs to be rewarded better, succession planning that needs to begin happening, product features that are missing shifting market cues or market opportunities that are being left wide open. Give some thought to opening up your business to new voices in 2022, it might bring a road to Damascus moment.

This marks my 500th article in the Business Daily as The Nitpicker for the last 13 years. My many long suffering editors have continued to give me a voice on this respectable forum, and to all of them I want to say Asante Sana!

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Twitter: @carolmusyoka

Imperial Audit: 42 Billion Reasons Why Directors Should Be Cautious

[vc_row][vc_column width=”2/3″][vc_column_text]A pilot was welcoming passengers to the flight shortly after take off. “Thank you for flying with us this morning. The weather is…..” He broke off his welcome with a sharp scream followed by, ”Oh my God, this is going to really hurt. It’s burning.” There was complete radio silence for a full minute before he returned. “Ladies and gentlemen I sincerely apologize for that incident, as I dropped a very hot cup of coffee on my lap. You should see the front of my trousers!” Out of the back came a worried shout from a passenger, “If you think yours are bad, you should see the back of mine.”

The Imperial Bank forensic report is out and any bank director, actually scratch that, any director of a Kenyan company should be having severe indigestion right about now. Following its findings, the Central Bank (CBK), the Kenya Deposit Insurance Corporation (KDIC) and the bank in receivership have sued nine individuals, one deceased person’s estate and eight companies in a bid to recover Kshs 42.4 billion of the banks assets and deposits. Yes, the figure is simply eye watering by its sheer size. This civil suit represents a watershed moment for corporate governance in Kenya. With the exception of three independent non-executive directors (INEDs), the other seven individuals (including the deceased) were directors representing the eight companies that were shareholders in the bank.

While the individuals are being sued for breach of fiduciary duty – a basic tenet of corporate governance – the companies therein named are being sued as being beneficiaries of what may come to be Kenya’s single largest corporate fraud since the 19th century explorer Henry Morton Stanley stepped off a boat onto Kenyan shores.
Over the period of ten years from 2006 to 2016, the bank was found to have operated two banking systems, with the illegitimate system passing through over billions of shillings in fraudulent disbursements over that period. The non-executive directors, including the chairman, were tightly joined at the hip and had cross shareholding in various other companies some of which were property related. In view of the fact that this was starting to look like a brotherhood of veritable kleptomaniacs, the three INEDs who joined in quick succession- two who joined on 1st of July 2014 and one on 1st February 2015- may not have been on the board long enough to cotton on what was, and had been, going on for the previous nine years. But today they are jointly and severally liable for years of mismanagement. These chaps were probably pleased as punch to have made it to the board at all and may have been snookered by the fast talking CEO, whose verbosity is alleged to have steamrolled various discussions on the board audit committee which he regularly attended. Now the three INEDs have to get lumped with the other directors all of whom have been painted with a mouthful of accusations over and above breach of fiduciary duty including negligence, gross negligence, fraud and theft.

One could very well argue then, that banks owe a duty of care to their directors to provide rigorous training in both corporate governance and risk management. There are now 42.4 billion reasons why bank directors need to know what they are signing up for. Actually, I could kick it up a notch and say that the CBK should require a made-for-purpose bank director training that one must undertake before they sign off on those ‘Fit and Proper Forms’ that are required for any bank director and senior officer before appointment to the board.
Yet the CBK is not entirely blameless in this mess, as all this happened on their watch. The regulator cannot claim that it relied on audited accounts to arrive at their conclusions for renewal of licenses. There were glaring irregularities in the governance such as the Board Executive Committee undertaking the role of the Board Credit Committee (BCC) without the proper structures in place including having an INED chair the BCC as per Prudential Guidelines. There were allegedly no notices for or minutes of meetings for a BCC from as far back as 2006. Someone was asleep at the wheel over at the banking supervision unit. The lack of INEDs until February 2014 should also have raised a slap on the wrist from the regulator. But it doesn’t appear to have. The only redemption here is that the regulator eventually stepped in, and quite likely because there was a new sheriff in that town.

Whether that amount of money is feasibly recoverable is something for the courts to determine. And directors should not try and draw comfort that they can ask the companies whose board they sit on to put in indemnification provisions in the articles of association or in their appointment letters. Section 194 of the Companies Act 2015 specifically voids any provisions that a company may make to exempt directors from any liability that attaches from negligence, default, breach of duty or breach of trust. However, companies are permitted to purchase Director and Officer (D&O) Liability Insurance to provide that specific indemnity from negligence etc. But there’s a catch. The same Companies Act does not allow D&O cover to provide indemnity (i) against fines from criminal proceedings, (ii) fines from regulators for non-compliance, (iii) defense of criminal proceedings and, finally, (iv) defense of civil proceedings brought by the company itself in which judgment is given against the director.

Therefore even if the Imperial directors had D&O cover, such cover busts two out of the four prohibitions above, viz (ii) and (iv) since the company is the plaintiff in the civil suit.

What’s the moral of this sordid story? Being a director of any company is risky business. Being a director on a board full of business buddies is even murkier business, the kind that requires one to keep a set of adult diapers on hand as they undertake the flight of their lives.
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