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How to Protect your Interest in a Closely Held Corporation

On Behalf of | Mar 31, 2022 | Business Law

Communication and exchange of ideas and goals between majority shareholders (typically the founders) and minority shareholders (often the silent investors) are ideal at the start of any new enterprise. Personal conflicts – or rather, business disagreements – frequently develop during a corporation’s existence and activity, and relationships deteriorate.

Majority shareholders, for example, may refuse access to financial or other business books, postpone dividends, raise wages for majority shareholders/officers, so de-facto diverting cash from minority shareholders or simply waste corporate assets. Similar scenarios are particularly concerning in the context of closely owned firms when the shares are (more or less) illiquid. As a result, the mistreated shareholder may find themselves trapped.

The best way to avoid these tragic scenarios is to negotiate protections with bullet-proof measures in the shareholders’ agreement at the start of the company relationship. This is why seasoned investors are typically wary, and even when they are on the verge of investing in a project, they rarely fall in love with the founders.

The following are some of the contractual tools that can help defend a minority shareholder’s position:

  • Right of first refusal: the ability to match a third-party purchaser’s offer to purchase the shares of another shareholder. This is beneficial in preserving the minority shareholder’s ownership percentage and avoiding being forced to do business with a stranger in a closely-held organization. In simple terms, tag-along rights are an option to participate in the sale of shares intended by one or more majority shareholders.
  • Minority shareholders have the right to appoint one or more members to the board of directors or to appoint an officer to represent their interests.
  • Although minority shareholders are at danger of oppressive actions, there are a number of instances where majority shareholders are confronted with unjustified filibustering activity by minority shareholders. In these situations, the majority shareholders may want to consider a “nuclear” option: a squeeze-out or freeze-out merger, in which the majority shareholders form a new corporation that is entirely owned by them and transfer all or most of the assets of the existing corporation to the new surviving entity. This result can be achieved in several US states with the permission of a majority of directors and shareholders. In other words, minority shareholders are pushed out of the company without a say. They do, however, have the right to a cash redemption for their shares at “Fair Market Value” (FMV). As a result, in the (possible) event of shareholder disagreement over the FMV of minority shareholders, the latter can seek a binding assessment through the courts. Minority shareholders have the right to object to a merger that has been approved, but courts usually uphold it as long as it serves a corporate purpose.

Contact attorney David Frangos of Frangos Legal LLC if you would like to discuss a new or existing shareholder agreement and how you can protect yourself from the pitfalls of a current or future business partnership. Schedule a Free Consultation and case review by emailing us at [email protected], by telephone at 317-348-2150, or by booking online.