MINORITY SHAREHOLDER PROTECTIONS: SAFEGUARD YOUR INVESTMENT AS A MINORITY OWNER IN A COMPANY, PART ONE
June 3, 2015
By James Forrest
Starting a business is almost always an exciting and fun time for entrepreneurs, full of high hopes and positivity. As rightly it should be! No one usually, however, anticipates major disagreements or the need for legal intervention down the road. But as business attorneys for many years, we are here to tell you that these things do happen unfortunately, and it is best to think through various scenarios in advance.
The good news is that there are ways to minimize your risks as a business owner. One of those ways is to create a shareholders’ agreement when forming the company. This gives the owners an opportunity to agree on terms that are best for the company at a time when everyone is congenial. This type of agreement addresses important contingencies like death, divorce, disability, what happens if a partner isn’t performing, etc. A good shareholders’ agreement can be extremely valuable to a company to navigate through unforeseen circumstances.
Many of our clients at the Forrest Firm are businesses with multiple owners, and it’s very common for at least one of the owners to be a minority shareholder—one who owns less than 50 percent of the business.
In this and our next blog post, we will discuss several measures that minority owners should try to include in their arrangement to protect their interests in the company.
Appointing Directors or Managers
One way to ensure some level of control as a minority shareholder is to have the right to elect someone (often yourself) to the company’s governing body (either a Board of Directors or Managers usually). As a minority owner, you typically won’t have the right to control the governing body, however, having a place at the table is important as it allows your voice to be heard and influence the direction of the company.
Pre-emptive rights allow you to participate in any future offering to ensure your percentage interest in the company is maintained. So, for example, if you own five percent of the company, and the company offers additional shares to a third party (which would dilute your five percent to something less), you would be allowed to purchase additional shares in the company so that you could maintain the five percent ownership level. Be aware, however, that this can cause delays in stock sales and turn away institutional investors, and is something we don’t see given to many minority equity owners.
Limitations on Affiliate Transactions
As a minority owner, you want to limit the other owners’ ability to extract cash from the business in a way that would prevent distributions. For example, if your other two partners both work in the business, you’ll want to try to limit their salaries to market salaries. Otherwise, they could both pay themselves astronomical salaries and prevent the company from ever making shareholder distributions. It is somewhat common for all shareholders (particularly in a closely held company) to have to approve all “affiliate transactions” (any contract between the company and a shareholder, which can include employment agreements).
Stay tuned for our next post, when we will share more protections for minority shareholders.