MINORITY SHAREHOLDER PROTECTIONS: SAFEGUARD YOUR INVESTMENT AS A MINORITY OWNER IN A COMPANY, PART TWO
June 10, 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 our last post, we discussed several measures that minority owners should make sure to include in the shareholders’ agreement, including appointing directors/managers, pre-emptive rights, and restrictions on affiliate transactions.
Let’s take a look at a few more provisions that are important for minority shareholders.
Although no entrepreneur ever predicts a dispute among the owners, disagreements do happen and sometimes cannot be resolved. Sometimes a “shotgun clause” can be valuable. A shotgun clause gives a minority shareholder the right to buy or sell his/her shares to another shareholder if an issue regarding the company’s operations or sale cannot be resolved. When a shotgun clause is triggered, one shareholder will offer to purchase another shareholder’s shares or sell his/her own at the same price. Either way, one shareholder is leaving and one is staying. This can prevent deadlock which impedes the forward momentum of a business.
A piggyback clause (or “tag-along rights”) protects your investment should the company be sold. When a majority shareholder decides to sell his/her shares to a third party, a minority shareholder can “piggyback” onto the original shareholder’s offer to the third party, and offer to sell their shares to the third party for the same agreed upon price. The third party can then only buy the shares of the majority shareholder if he/she agrees to purchase all the shares of all other shareholders who wish to be bought out.
Minority shareholders should try to establish (preferably in writing) some reporting guidelines. It is always helpful to have quarterly or monthly reporting from the CEO or other authorized officer so that you can stay informed regarding the status of the company’s operations over a period of time. This prevents surprises that arise from only checking in once a year or so.
There are certain decisions which may trigger higher than normal approval thresholds, such as issuing stock to new owners, selling the company, large vendor contracts, dissolving the company, etc. For those types of “big-ticket” decisions, often the company must procure approval from a certain percentage of the owners (i.e., often times 75-90 percent). The percentage threshold, as well as what decisions qualify for this heightened scrutiny, is often subject to fairly intense negotiation.
Minority business owners, despite their minority ownership percentage, should still have some protection. The attorneys at the Forrest Firm help entrepreneurs draw up agreements to address issues like these regularly and are happy to consult with you or your company. We will make sure you protect your investments appropriately with the right legal agreements.