A reader recently wrote a very good question about minority shareholders, and I thought the situation would be worthy of posting. Here is the question, and answer, with permission.
"Hi,
I read your article about minority shareholders. I got an offer to become a shareholder of a small company without paying anything, just because I have been working for them for a period of time.
However, my plans are to go to grad school and then after a year or two look for a position in a large company. Can I then go to work for another company if now I've agreed to become a shareholder of the small company that is just starting? If not, can I, after a year or two, tell that small company that I don't want to be a shareholder anymore? I'm being told by the other shareholders that everything will need to be confidential, so I don't know if my husband and I can show the shareholder agreement to a lawyer."
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First, understand that I am only licensed to practice in North Carolina, and this does not constitute legal advice.
Second, at least in North Carolina, but usually in other states, it is a general industry practice that any agreements which would involve you personally but are labelled "confidential" can still be studied, shared, reviewed by legal counsel before you decide to sign it. Still, the best practice is to let the others know you'd like your personal attorney to review the documents.
Finally, there are two things which may prevent you from joining a big company while still a shareholder of the smaller one. The first is that (assuming their businesses are similar), if you're involved with the smaller company, you owe a duty of loyalty to that smaller venture. If you go to another company, you are not able to use your best efforts for the smaller company. In fact, your actions may go further and violate specific provisions of your shareholders' agreement.
The second issue is also a serious one: what if you just give up your stock rights and leave the company; will that solve everything? There still may be a problem if the remaining shareholders allege that you are using proprietary or confidential information you obtained while a shareholder in the small company. This may specifically violate terms of your shareholder's agreement (which may contain a non-disclosure provision) or it may violate your state's common law rules (i.e., civil rules created by caselaw) regarding what information from your former employer/partnership/venture/etc. that you can use once you leave.
The best thing you can do? Be upfront with the other shareholders, and negotiate a provision that, while protecting their interests, allows you the freedom one day to leave for bigger things: e.g., perhaps an agreement that allows you to leave and join a competing business, but provides that the remaining shareholders can buy out your interest at a fair price (the determination of which would be a subject in itself). If they won't agree to this, both sides are already on notice that there will be a potential conflict in the future--so why buy into it? Either walk away, or understand you may have a fight on your hands when you leave.
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Sabtu, 05 April 2008
Minggu, 29 April 2007
Think Before You Invest as a Minority Shareholder
You've got a little extra money in your pocket, and you're looking to invest. Somebody comes to you with a great business idea, and offers to cut you in on it. For just $X, you can own a five percent, 10 percent, 49 percent share in the company, and it has a lot of potential!
I have clients who are approached with these situations every day. Some are wealthy people who are actively searched out to be investment partners in large-money ventures. On the other extreme, some are humble folks, who are considering (or have) poured what little savings they have into a new start-up company. Before you invest as a minority shareholder in a company, consider these tips, and think about the cautionary tales below.
DEFINITION OF MINORITY SHAREHOLDER: a minority shareholder is someone who holds less than a 50 percent ownership interest in a company. I'm using the term loosely to not only include true stockholders in a corporation, but, for example, partners in a partnership or members in a limited liability company. If you hold less than a 50 percent interest in a company, some one or some group of people have the potential to outvote you on company governance matters.
1. What management rights will you have in the company? In consideration of your buying into the company, will you have any rights to control the daily operations of the company, other than your rights as a minority shareholder? Often, the people who start up the company want to retain majority ownership, and are looking to other investors to provide capital, yet still leave control with them. This isn't always bad, but remember, if you're not guaranteed a position as a director or an officer, you're just a shareholder, and one who can be outvoted.
2. What dividend or payout rights will you have in the company? Are there any benchmarks or rights that you'll have to receive money or profits? Too many novice investors blindly invest money in a friend's or acquaintance's speculative company, just to find once they've put their money in, that their money is not bringing them any return. Will you receive any dividends or payments? Or are you just hoping that the value of your investment will go up? Ask these questions at the beginning!
3. What buy/sell rights will you have in the company? In its simplest form, an investor should invest in ownership of a company because he thinks the company will grow, and thus will his investment. However, if you're a minority shareholder, you may not be able to control the direction of the company. What happens if you want to sell out? Can you? Or are you held hostage to the majority interests of the company? A minority interest in a company in which you can't sell your interest is practically worthless.
4. What are the other investors contributing?
Sometimes, the investors trying to get you to invest are contributing their own money, dollar for dollar. Other times, however, the investors are wanting
you to contribute the money, and yet they retain a majority of the stock. This is neither good or bad inherently, but you need to understand. If your $100,000 investment buys you a 49 percent share of a company, and the start-up investor has put in $100,000 yet wants to retain 51 percent ownership, that might be reasonable in some cases. If you're being asked to put up $100,000 for a 10 percent share, and the start-up investor has nothing but his brilliant dream, and wants to retain 60 percent ownership, you need to think about the deal a little harder.
5. Consider a Shareholders' Agreement. If you trust the other investors, and you agree that all interests should be protected, the best thing you could do is to have the attorney setting up the company draw a shareholders' agreement, a buy/sell agreement, or something similar. It, in essence, is an agreement for small companies that is set up to protect the interests of the individual investors. It often guarantees each investor a management position (such as a guaranteed spot on the corporate board of directors), and provides buyout provisions in the event of a dispute.
By way of example, I've recently handled two situations involving investors in small corporations.
In the first case, a tearful woman came in to me after she'd invested in a small corporation. She and a former co-worker had been involved in the dress design business together, and then decided to start their own. The co-worker would get 90 percent ownership, and she, for her smaller monetary contribution, would get 10 percent. They both were supposed to work as employees of the company. Unfortunately, things didn't work out, they got into a dispute, and she was fired as an employee. She was completely shut out of the company's business, and watched as her former friend continued to hire new employees and run the company without her, not providing her any idea of profits or losses. She now wants to be bought out, but under the corporate agreement she entered, the majority partner can buy her interest out with payment, over a long period of time, at a very low interest rate, such that she would likely be paid $100 per month until her interest is paid off in a few years. It's unfortunate, but she did not, when entering into the agreement, make provisions for minority shareholder rights, and has in effect given the majority shareholder money that he really doesn't have to repay.
By contrast, another client of mine hired me before the fact to review a proposed investment for him. This investor had extensive knowledge in science, and owns a chain of stores in his specific field of expertise. He was approached by a scientist and another businessman about going together and starting up a company that would create, market and sell a new invention that the scientist had created. This invention was something my client could visualize, and he knew that, if created, it could save his own business a lot of money, so he knew it was a potentially good idea.
The scientist and businessman wanted my client to invest a large sum of money for a 25 percent interest in the company. If my client desired, he had the right, within a two-year period, to purchase an additional 25 percent interest in the company for a similar sum of money.
I read the documents over numerous times, and spoke to my client about what he visualized the company doing, and what he wanted from the company. I told him I saw a few problems with the agreement:
1. The scientist and businessman were not putting any money into the company, other than their own "sweat equity." Therefore, they had less to lose.
2. The scientist and businessman would each be a director, and my client would be the third director--which meant he could always be outvoted.
3. My client, though putting forth all the money, would not have a majority interest as a shareholder.
4. In fact, the contract was written so that, after a given time, my client had to re-convey a 10 percent interest in the company to the company's employees, therefore guaranteeing that he would become a minority shareholder.
I told my client that I couldn't speak to the wisdom of the business plan, but I didn't like the fact that he was putting up all the money, yet he could be shut out of the control of the company, and furthermore had no way to force returns or the sale of his stock if the business were successful.
We sent a letter back to the gentlemen, nicely telling them that my client was interested in investing, but only if he could have more safety, and outlined some proposals that would protect my client's rights as a shareholder. He never heard from them again, and far from blaming me for "killing" a deal, he thinks that I saved him from potential trouble.
If you have questions about investing in a small company, contact me at wldeaton@vnet.net.
I have clients who are approached with these situations every day. Some are wealthy people who are actively searched out to be investment partners in large-money ventures. On the other extreme, some are humble folks, who are considering (or have) poured what little savings they have into a new start-up company. Before you invest as a minority shareholder in a company, consider these tips, and think about the cautionary tales below.
DEFINITION OF MINORITY SHAREHOLDER: a minority shareholder is someone who holds less than a 50 percent ownership interest in a company. I'm using the term loosely to not only include true stockholders in a corporation, but, for example, partners in a partnership or members in a limited liability company. If you hold less than a 50 percent interest in a company, some one or some group of people have the potential to outvote you on company governance matters.
1. What management rights will you have in the company? In consideration of your buying into the company, will you have any rights to control the daily operations of the company, other than your rights as a minority shareholder? Often, the people who start up the company want to retain majority ownership, and are looking to other investors to provide capital, yet still leave control with them. This isn't always bad, but remember, if you're not guaranteed a position as a director or an officer, you're just a shareholder, and one who can be outvoted.
2. What dividend or payout rights will you have in the company? Are there any benchmarks or rights that you'll have to receive money or profits? Too many novice investors blindly invest money in a friend's or acquaintance's speculative company, just to find once they've put their money in, that their money is not bringing them any return. Will you receive any dividends or payments? Or are you just hoping that the value of your investment will go up? Ask these questions at the beginning!
3. What buy/sell rights will you have in the company? In its simplest form, an investor should invest in ownership of a company because he thinks the company will grow, and thus will his investment. However, if you're a minority shareholder, you may not be able to control the direction of the company. What happens if you want to sell out? Can you? Or are you held hostage to the majority interests of the company? A minority interest in a company in which you can't sell your interest is practically worthless.
4. What are the other investors contributing?
Sometimes, the investors trying to get you to invest are contributing their own money, dollar for dollar. Other times, however, the investors are wanting
you to contribute the money, and yet they retain a majority of the stock. This is neither good or bad inherently, but you need to understand. If your $100,000 investment buys you a 49 percent share of a company, and the start-up investor has put in $100,000 yet wants to retain 51 percent ownership, that might be reasonable in some cases. If you're being asked to put up $100,000 for a 10 percent share, and the start-up investor has nothing but his brilliant dream, and wants to retain 60 percent ownership, you need to think about the deal a little harder.
5. Consider a Shareholders' Agreement. If you trust the other investors, and you agree that all interests should be protected, the best thing you could do is to have the attorney setting up the company draw a shareholders' agreement, a buy/sell agreement, or something similar. It, in essence, is an agreement for small companies that is set up to protect the interests of the individual investors. It often guarantees each investor a management position (such as a guaranteed spot on the corporate board of directors), and provides buyout provisions in the event of a dispute.
By way of example, I've recently handled two situations involving investors in small corporations.
In the first case, a tearful woman came in to me after she'd invested in a small corporation. She and a former co-worker had been involved in the dress design business together, and then decided to start their own. The co-worker would get 90 percent ownership, and she, for her smaller monetary contribution, would get 10 percent. They both were supposed to work as employees of the company. Unfortunately, things didn't work out, they got into a dispute, and she was fired as an employee. She was completely shut out of the company's business, and watched as her former friend continued to hire new employees and run the company without her, not providing her any idea of profits or losses. She now wants to be bought out, but under the corporate agreement she entered, the majority partner can buy her interest out with payment, over a long period of time, at a very low interest rate, such that she would likely be paid $100 per month until her interest is paid off in a few years. It's unfortunate, but she did not, when entering into the agreement, make provisions for minority shareholder rights, and has in effect given the majority shareholder money that he really doesn't have to repay.
By contrast, another client of mine hired me before the fact to review a proposed investment for him. This investor had extensive knowledge in science, and owns a chain of stores in his specific field of expertise. He was approached by a scientist and another businessman about going together and starting up a company that would create, market and sell a new invention that the scientist had created. This invention was something my client could visualize, and he knew that, if created, it could save his own business a lot of money, so he knew it was a potentially good idea.
The scientist and businessman wanted my client to invest a large sum of money for a 25 percent interest in the company. If my client desired, he had the right, within a two-year period, to purchase an additional 25 percent interest in the company for a similar sum of money.
I read the documents over numerous times, and spoke to my client about what he visualized the company doing, and what he wanted from the company. I told him I saw a few problems with the agreement:
1. The scientist and businessman were not putting any money into the company, other than their own "sweat equity." Therefore, they had less to lose.
2. The scientist and businessman would each be a director, and my client would be the third director--which meant he could always be outvoted.
3. My client, though putting forth all the money, would not have a majority interest as a shareholder.
4. In fact, the contract was written so that, after a given time, my client had to re-convey a 10 percent interest in the company to the company's employees, therefore guaranteeing that he would become a minority shareholder.
I told my client that I couldn't speak to the wisdom of the business plan, but I didn't like the fact that he was putting up all the money, yet he could be shut out of the control of the company, and furthermore had no way to force returns or the sale of his stock if the business were successful.
We sent a letter back to the gentlemen, nicely telling them that my client was interested in investing, but only if he could have more safety, and outlined some proposals that would protect my client's rights as a shareholder. He never heard from them again, and far from blaming me for "killing" a deal, he thinks that I saved him from potential trouble.
If you have questions about investing in a small company, contact me at wldeaton@vnet.net.
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