Watch Out for These Pitfalls of Minority Ownership
Provided by HG.org
Many individuals dream of owning a business during some point in their life. Some invest a small percentage into a business while leaving themselves available for other investments or full-time employment. When there are owners with a larger interest than these individuals, it is important that minority owners understand their rights and their limitations.
Ways of Acquiring a Minority Ownership
Individuals may accumulate a minority ownership in a company in a number of ways. They may be brought in early on in the business when there is not much capital when they provide important services to the business and are paid in equity rather than in cash. This can also occur when an investor puts a certain amount of money into a business and receives a percentage of equity. Divorce or inheritance can also pass property from one person to another. Employers may allow employees to invest in a certain amount of stock in the business. In all cases, the ownership interest is lower than the majority interest owned by someone else.
Limited Rights of Minority Owners
Minority owners do have certain rights as a shareholder that are usually outlined in the business’ operating agreement. These rights usually include receiving a proportionate share of proceeds if the business is sold or dissolved. When profits are distributed, minority owners also receive a share of this distribution. Minority owners can sue the business if the majority owner engages in conduct that can jeopardize their interests. Additionally, they usually have a right to examine the books and financial records of the company to ensure that their interests are protected. However, these rights are often limited and inferior to the rights of the majority owner.
No Right to Make Management Decisions
Minority owners generally do not have the right to address daily issues that the business confronts. The business may have a board of directors that are responsible for the direction and operation of the business. Minority owners do not generally have a right to make management decisions for the business. This allows minority owners to maintain more power over the course of the business that the minority owner may not agree with but may have no recourse to address. These decisions can have a direct impact on the business and its value, potentially jeopardizing the minority owner’s interest in the business.
Limited Ability to Enforce Distributions
Minority owners have a limited ability to demand a distribution from a business that is currently operating. Majority owners can bypass this right by simply not making any distributions of profits for any owners by employing a number of creative strategies, including keeping large reserves for future expenses or opportunities, paying high salaries to directors and key personnel, investing in new business equipment or spending excessively so that there are no profits remaining in the business. Majority owners may be able to sidestep any possible liability or exposure to lawsuits so long as their actions are not so grossly unreasonable as to raise negative implications by a court.
Limited Right to Sell Ownership
Minority owners often have limited rights when it comes to having their interest bought out for a fair value. State law may provide some rights to require the business to buy out the owner’s minority share. Additionally, even if the business gets sold, a sale can be structured in such a way that minority owners are not compensated for their interest. For example, a business may sell the business assets over a prolonged period of time while reinvesting the proceeds in a different business. This can have the effect of limiting the profit of the business so that there is little to nothing owed to minority owners.
Negotiating Better Agreements
Minority owners who do not want to expose themselves to the risks of minority ownership may wish to structure better agreements that better protect their interests. The owners of the business may be able to negotiate the terms of minority ownership that includes provisions that are more favorable to minority owners, upon their request. The ability for owners to negotiate how the business is run or which rights business owners will have is largely left to the discretion of the business. A minority owner may wish to consider whether he or she wants to have involvement in daily management, be able to make certain decisions regarding the business, how to be bought out or how profits should be distributed. A business lawyer may be able to negotiate more favorable terms.
Read more on this legal issueHow to Remove a Shareholder from a Business
Essential Clauses in a Founder’s Agreement
Common Legal Mistakes to Avoid in Your Business
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.