At the outset of any new venture, communications and sharing of ideas and goals between majority shareholders (often the founders) and the minority shareholders (often the silent investors) are idyllic. During the corporation life and its activities, personal issues – or anyway business disagreements – arise frequently, and the relationships go sour.
Minority shareholders are in a particularly risky and weak situation, where their rights risk being infringed in several ways. For instance, the majority shareholders might deny access to financial or other corporate books or postpone dividends, raising salaries to majority shareholders/officers, thus de-facto diverting funds from minority shareholders, or simply wasting corporate assets. Similar situations are especially disturbing in the context of closely-held corporations because the shares are (more or less) illiquid. Therefore, the oppressed shareholder might very well end up stuck.
The best way to prevent these unfortunate situations is by negotiating protections at the outset of the business relationship with bullet-proof provisions in the shareholders’ agreement. This is why seasoned investors are always skeptical, and even when they are close to deciding to invest in a project, they hardly fall blindly in love with the founders. Some of the contractual tools that help protect the position of a minority shareholder are:
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Right of first refusal: an option to match the offer of a third-party purchaser that intends to purchase the shares of another shareholder. This is helpful to maintain the minority shareholder’s ownership percentage unchanged and to avoid being forced to be in business in a closely-held corporation with a stranger.
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Tag along rights: in simple terms, an option to join the sale of the shares intended by one or more majority shareholders.
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Appointment rights: when the minority shareholders can bring one or more members to the board of directors or appoint an officer to pursue their interests.
Although the minority shareholders risk suffering oppressing practices, there are a number of situations where the majority shareholders are faced with unreasonable filibuster behaviors displayed by the minority shareholders. In these cases, the majority shareholders can consider a “nuclear” option: a squeeze-out or freeze-out merger, which occurs when the majority shareholders set up a new corporation wholly owned by them and transfer all or most of the assets of the existing corporation to the new surviving entity. In many US states, this result can be accomplished with the approval of the majority of directors and shareholders. In other words, the minority shareholders are squeezed out without having a say. However, they have the right to receive a ”Fair Market Value” (FMV) cash redemption for their shares. Therefore, in the (likely) event of disagreement among the shareholders regarding the FMV of the minority shareholders, the latter can resort to court remedies for a binding appraisal. Minority shareholders also have the right to dissent and oppose the approved merger, but courts tend to affirm it as long as it serves a corporate purpose.