- As part of the initial formation of a business, a minority owner should proactively seek rights with respect to the management and economics of the business.
- While a majority owner will generally have the ability to control the business and likely also have veto rights over big decisions, a minority owner with negotiating power may be able to obtain certain rights regarding management and protection to prevent minority oppression.
Minority owners of a business face unique challenges. With limited or no control over the management and governance of a business, minority owners can be unfairly left in the cold or squeezed out. However, deliberate preparation and negotiation at the initial stages of the business can set up minority owners with the necessary tools to eliminate or reduce many of these difficulties and even avoid future conflict.
Those with ownership stakes in privately held businesses, partnerships, or family offices need to closely collaborate with and trust others. When disagreements and disputes over rights and responsibilities arise, individual emotions and personalities can complicate matters. This ongoing series will help owners anticipate potential problems when structuring their businesses and find solutions to issues that commonly arise among owners of privately held businesses, both before and during litigation.
Upon formation of the business, minority owners should consider the following issues when negotiating the company’s operating agreement, shareholder agreement, or partnership agreement:
- Management matters. If possible, minority owners should seek the right to appoint a board member (of a corporation) or manager (of an LLC), whether through cumulative voting or a board seat reserved to the minority owner. Minority owners may also want to negotiate for veto rights over certain major decisions. At the least, minority owners should ensure that they have rights to inspect the company’s books and records, either by statute or by contract. (See our previous post regarding books and records issues.)
- Economics. Minority owners should consider whether they have the negotiating power up front to protect their ownership interests from dilution by subsequent investors. Minority owners should also consider negotiating for required periodic distributions to ensure cash flow (particularly tax distributions).
- Employment. In many cases, a business owner’s employment with the company is a key reason for their investment. Minority owners should pay close attention to the circumstances in which their employment can be terminated and to the rights of owners after their employment is terminated. Minority owners may even seek to have the right to exit the business entirely in the event their employment is terminated.
- Exiting the business. Minority owners should push for some ability to exit the business and to control circumstances in which their equity is sold. For example, under what scenarios can the owner sell their interest? If a potential buyer seeks to acquire the entire business, is the majority able to force the minority owner to sell (and does the minority owner have the right to sell on the same terms as the majority)?
- Disputes with the majority. Often when a minority owner has a dispute with the majority owner, the majority owner is entitled to indemnification from the company (and advancement of expenses) for costs associated with the dispute. This results in a situation where the minority owner is on the hook for their own fees plus (indirectly) a portion of the fees of the majority owner. Minority owners should consider whether they are able to limit or avoid this liability in advance. It is also important to assess the fiduciary duties that the majority owes to the minority under law and whether those duties have been modified.
Thoughtful negotiation of protections early in the process of setting up a business may avoid problems for minority owners. Still, as time goes on, minority owners may decide that it is in their best interests to exit the business or pursue litigation. We encourage owners to look out for our upcoming posts on a minority owner’s ability to exit a business and a deeper dive into disputes between minority and majority owners.