Dragons’ Den. A simple concept – introduce entrepreneurs with innovative business ideas to Dragons; highly experienced individuals with contacts and cash to invest. The pitches make for good TV – sometimes slick & brilliant, sometimes “hide behind a cushion” excruciating, once the forensic interrogation begins.

Of course, this coming together of small businesses needing investment, and investors with cash to invest, has been happening since time immemorial, long before the cameras started to roll. Many small businesses have grown to their fullest potential as a result of inward investment, whether from owners' friends, family or contacts or from the more formal channels of private equity/venture capital.

Presently, the impact of the pandemic may accelerate the need for some small businesses to look to third parties for investment.  But what are the relevant considerations?

On the show we see Dragons offering cash sums and the benefit of their wisdom in return for a % stake in the company. Away from Dragons’ Den, it is instructive to consider what that means in the case of a small business owner accepting inward investment from a family member, friend or business contact, in return for shares (even a small stake) and a role in the company. Effectively, it means giving away a proportion of the company – an ownership stake, thus creating a co-ownership. A founder who previously wholly owned their company, 100%, will no longer do so; can no longer consider it “his/her” company. And that commitment, once entered into, is not easily reversible on a change of heart.

Unsurprisingly, this can and does happen, especially where relationships break down, disagreements arise or perceptions of unfairness creep in. Aside from simple falling outs, disputes can arise around a myriad of issues: strategic direction; dereliction of duty; inequality in day to day effort/input relative to financial reward (whether dividends or salaries); expenses taken from/charged to the company; perceived conflicts arising from other business interests; power & influence. Such disputes at shareholder level, unless managed quickly and carefully, can stifle a company.

The position between shareholders in a company is regulated by contract – both the Articles of Association (obligatory for any company, with a default to the “Model” Articles, to which scant attention may have been paid) and any written Shareholders’ Agreement (not obligatory, but highly advisable and can be bespoke). It is to these that the parties/Court must look in the event of a dispute.

While few people enter into a marriage envisaging the divorce, small business owners looking for their own dragon should have one cautious eye on ensuring the right contractual framework to ensure clarity, maximise protections and mitigate risks. Why? Because, while the ultimate outcome (co-ownership) is what it is, the ground rules can be set and the terms of the deal (in particular the relative voting rights) will provide the road map in the event of a dispute.

Considerations include:

  • what % share to give? (regularly negotiated in the Den). Important, since the % determines the voting & veto power at shareholder level – retention of a 75% holding will ensure ability to control; conversely, a 50/50 arrangement, which may sound “fair” when relations are good, leads to deadlock when they are not.  Note that even a small % shareholder with little voting power (unable to pass or block resolutions) remains nevertheless a co-owner with shareholder rights;
  • what day-to-day role in the company each participant will have, and are employment contracts required to ensure clarity around the required inputs? (again, highly advisable);
  • how the board will be constituted, with consideration to any risk/impact of deadlock at director level (again, this can stifle a company);
  • whether provisions should/can be included to facilitate a take back of shares for nominal value in the event of certain happenings (e.g. misconduct leading to dismissal etc) – “bad leaver provisions”;
  • who owns the intellectual property?;
  • finally, and most importantly, “do I know……really know…the person I am bringing in?”

While some of this might seem too complicated or sensitive to raise during the flush of positivity when collaboration and investment is first being discussed, and while in truth it is impossible to mitigate entirely against a dispute arising or its impact, it pays to have eyes wide open to the risk profile and everything properly agreed and documented. Because nobody wants to find themselves stuck if their dragon, apparently sleeping and placid at the time of investment, becomes uncontrollable and destined to wreak havoc some way down the line.