Becoming a minority owner in a business can give you the opportunity to help a business grow and share in its success without the management responsibilities.
Minority owners may be brought in to facilitate growth, perform acquisitions, or achieve other strategic goals and often provide valuable expertise in addition to the capital investment they make in the business. However, because a minority owner owns less than 50 percent of the business, and state business laws typically give minority owners limited rights, the minority owner may be at the mercy of the majority owners. If a conflict arises and the minority owner’s rights are infringed, they can file a lawsuit.
Conflicts can also be prevented through a written agreement that modifies state law and more strongly protects the minority owner against oppressive conduct.
Minority Owner Rights
Most companies have a small number of private owners and do not publicly issue ownership interests. Business entities such as corporations, partnerships, and limited liability companies (LLCs) may have this type of ownership structure. A minority owner is an owner who owns less than 50 percent of the business. They may, for example, invest $50,000 in a company in exchange for a 20 percent interest. Because a minority owner does not have a controlling stake in the business, however, they have fewer rights than majority owners. Generally, in the absence of a written agreement that expands their rights, a minority owner is only entitled to the following:
● The right to vote on certain matters, such as electing the board of directors (corporation) or managers (LLC)
● The right to inspect company books and financial records
● The right to receive dividends from the business (if there is a distribution of profits) and proceeds from the sale or dissolution of the business
● The right to sue majority owners for breach of fiduciary duty
Outside of these basic rights, minority owners may find that, despite their investment in the company, they have little or no ability to control the direction of the company and no right to participate in daily decisions. If the minority owner is also a company employee, they do not have the right to continued employment if they are fired. They also lack the right to demand distributions if the majority owner does not make them.
Oppression of Minority Rights
The rights of a minority owner, while limited, can be enforced based on state statutes that provide protections aimed at preventing “minority shareholder oppression.” In addition, although majority owners have nearly unlimited discretion over how to run the company, they still have a legal duty—known as a fiduciary duty—to not place their own interests above the interests of the company and its minority owners. However, depending on state law, the majority owner may owe fiduciary duties only to the company and not to a minority owner. Minority oppression may occur in situations such as the following:
● The majority owner refuses to make profit distributions when the company is profitable
● The majority owners are excessively compensated
● The majority owners dilute the voting rights or ownership of minority owners
● The majority owners unreasonably restrict the sale or transfer of minority membership interests
● The majority owners deny a minority owner’s access to financial records
● The minority owner is fired as a “squeeze play” to eliminate their ownership interest
Again, majority owners have a lot of leeway in how they operate the business, and not all of these examples will rise to the level of oppression in every case. To prove oppression, it may be necessary to show that the actions of the majority owner toward the minority owner not only interfered with the latter’s interests, but also were intentional. Making this determination requires a case-by-case analysis in accordance with the relevant facts and state law. A successful oppression lawsuit may result in the payment of monetary damages, a court-ordered buyout of the oppressed minority owner, or equitable relief, such as requiring the company to cease their specific oppressive actions.
Negotiating Stronger Minority Owner Protections
It may be that a minority owner has their eyes only on financial gain. But that goal can be in jeopardy if the majority owners find ways to spend and reinvest money that would otherwise be distributed to the minority owner as profits. Profits from a business sale cannot be guaranteed, either, if the sale is structured in a way that prevents minority owner payouts. Minority owners also cannot count on the ability to sell their ownership interest, since state law often limits the right to force a company buyout. However, minority owners do not have to accept the limited default rights they have under state
statutes. An operating agreement and a buy-sell agreement can include provisions that provide additional protections for minority owners.
Prior to obtaining a minority stake in a company, prospective owners should consider their expectations about the following types of issues:
● Level of involvement in day-to-day company management
● Decision-making authority regarding company changes, including the sale of the business or a merger or acquisition
● Equity payments from company operations
● The ability to sell an ownership interest or be bought out by the other owners
● Distributions from the sale or dissolution of the company
Initial expectations can be set during a discussion with business partners, but handshake agreements do not go far enough. The agreed-upon understanding between the minority and majority owners should be in writing and signed. Absent a written agreement that solidifies their rights, a minority owner relies on the majority owners’ good faith. Should that faith prove to be misplaced, a minority interest holder may realize—too late—how vulnerable they are to the majority.
Protect Yourself as a Minority Business Owner
Trust is important, but trust that is not backed up by written agreements will not get you very far if trouble arises. Some of these problems may not be anticipated until they arise. Others can leave you grasping at legal straws. As a minority business owner, you do not have to accept the limited protections that state statutes offer. It is fully within your power to negotiate more favorable terms as a condition of taking on a
minority owner role.
Before investing your time and money in a business venture, it is prudent to consult a lawyer. At Compass Rose Law Firm, our business lawyer can help you solidify your expectations with legally enforceable documents. If you already have agreements in place, we can also advise you of your rights to bring a breach of contract or minority oppression action. To discuss your needs, please contact our office and set up an appointment.