Business Articles THE MINORITY SHAREHOLDER: What a shareholder can do. by Mary Hanson

The minority shareholder issue comes up two ways. One is where you are the minority shareholder, wondering what you can do to either get treated better or get bought out. The other is where you are the majority shareholder wondering what to do about a minority shareholder.

In any analysis of "what to do," my advice includes looking at both sides of this issue. It's not as one-sided an issue as it may seem. The minority shareholder who feels trapped needs to understand the perspective of the majority shareholder.

The Majority Shareholder Perspective

The majority shareholder often wants very much to "get rid" of the minority shareholder. The concerns of the majority shareholder may include the following:

* The majority shareholder is working hard to build value and increase net worth. To have a minority shareholder who is not working for the business or who is not working as hard, means that the majority shareholder's efforts benefit the minority shareholder as well as the majority. The minority shareholder is "dead weight" to the majority shareholder.

* The majority shareholder wants to invest more money in the business, but doesn't want to make further investment in the business while there is the other shareholder involved.

*Relatives of one shareholder would be willing to invest or lend money for the business - if the business belonged only to "their" shareholder. Why should they put their money at risk when a non-relative gets a free ride from their risk? This feeling is even stronger if the other shareholder is a fifty percent shareholder and actively involved with the business. Too much of the "aid" benefits this "other shareholder." Even worse, the active "other" shareholder may be a poor business manager, increasing the risk of loss of the funds loaned by the relatives.

* The majority shareholder knows (or is told by advisors) to buy out the minority shareholder before the corporation gets bigger and more valuable. The best advice is always to buy stock when it's cheap. It particularly hurts a shareholder to work hard for many years and then have to buy out the minority shareholder - at high values resulting from the majority shareholder's own labor.

* The majority shareholder does not want to invite the minority shareholder to corporate meetings.

* The majority shareholder doesn't want to disclose financial information to the minority shareholder. He or she doesn't want the minority shareholder to know how well or how badly things are going, or know how much the majority shareholder has taken in salary and bonus. If the majority shareholder is engaged in any financial impropriety, he or she certainly doesn't want to reveal such information. If the corporation is doing very well, the majority shareholder may feel threatened by the prospect of giving financial information to the minority shareholder ("How will I ever get rid of the minority shareholder once they see how the corporation is growing!").

The Minority Shareholder "Squeeze"

The devious majority shareholder may come up with unethical or illegal approaches to getting the business away from the minority shareholder, such as:

* moving assets of the business away from the business; and

* starting another business and taking away the customers of the business.

If you are a majority shareholder, forget taking any such action. It's wrong, unethical, and illegal.

Other actions that can go either way (improper or proper) include:

* terminating the employment of the minority shareholder; and

* issuing more stock to dilute the minority shareholder's interest.

Sometimes these actions need to be taken for other reasons, but if the real reason is to squeeze the minority shareholder, don't do it. If it even looks like the real reason is an ownership interest squeeze, you shouldn't do it.

A squeeze that can be used in S corporations is the reinvestment of profits. Since S corporation shareholders pay taxes on their pro rata portion of the corporate profits (even if no profits are distributed), the majority shareholder may be able to run the business so that profits are high but no profits are distributed. The outside shareholders have to pay taxes on the S corporation profits without getting any money from the corporation to help pay the taxes. The insider shareholders may be able to pay themselves higher salaries to help them pay the taxes on profits, or may have personal wealth, so that the tax burden is not a problem for them.

Speaking of salaries, another squeeze on outside shareholders is to increase spending, including insider compensation, so there are no profits.

What can a minority shareholder do?

The Minority Shareholder Perspective

While a minority shareholder's involvement in a corporation may be limited to voting for directors, the minority shareholder is often a thorn in the side of management. There are actions that can be taken by the minority shareholder to make the majority shareholder desire more strongly to offer a buyout. First, the minority shareholder needs to understand the pros and cons of his or her situation.

From the viewpoint of the minority shareholder here are the problems:

* The stock of a closely held corporation has no real market, other than the other shareholders. First, it's not publicly traded stock. Second, any purchaser of the stock merely inherits the minority shareholder situation of the seller of the stock.

* The minority shareholder does not control the corporation. The minority shareholder often does not have enough shares to elect himself or herself to the Board of Directors. Even if he or she does have the voting ability to maintain a seat on the Board, being one director on a Board of 3 or more is not a powerful position. Unless other directors vote with you, being a director offers nothing to the shareholder, except the ability to be more of a "pain in the neck" to the majority shareholder.

* If the minority shareholder is a director, he or she has a right to attend meetings of the Board of Directors. Just as important is the corporation's need to give notice of meetings. If the insiders don't have a good relationship with this "outside" director, it becomes necessary for the corporation to provide formal notice to the outside director to comply with state corporation law. In order to have a valid meeting, notice requirements must be met. The majority shareholder is best advised not to take the risk that the minority shareholder objects to the lack of formal notice.

* The minority shareholder has a right to attend shareholder meetings, either in person or by proxy. Again, the legal requirements for notice must be met. The correct number of days' notice must be given before the meeting can be held, and certain types of actions to be taken at the meeting must be stated in the notice.

* If a meeting is held without complying with the corporation law formalities, any actions taken are subject to challenge.

* A shareholder's voting rights are limited to electing directors and voting on certain actions which require a shareholders' vote. Because the minority shareholder is outvoted by the majority, the power of the actual vote is usually limited. If the shareholder can be the swing vote between disagreeing factions of shareholders, this voting power can be strong rather than weak.

* The minority shareholder has rights according to corporation law to inspect records of the corporation and to receive financial statements of the corporation. Records subject to inspection under California law include the bylaws of the corporation, and the accounting books, records, and minutes of the corporation. The minority shareholder should assert his or her rights to view these records.

* The minority shareholder does not have any ability to hire employees, make management decisions, sign checks, or enter into obligations on behalf of the corporation, unless, of course, the Board of Directors has given this person some of these powers.

* As a minority shareholder, you can do little to object to poor business management and poor decisions. The negative side is that you can see your investment value deteriorate without being able to do much.

On the positive side, however, the minority shareholder does not have as much to lose as the majority shareholder. If the business is going well, the minority shareholder gets a "free ride." The majority shareholder's incentive to build a successful business may be great, even though the benefits accrue to the minority shareholder as well as the majority shareholder.

The Best Solution

No matter what the situation is, it is almost always best for both sides for one shareholder to buy out the other. Tension, lack of cooperation, and certainly sabotage or "punishment" of other shareholders or the corporation will destroy or at least injure the business.

The buying shareholder is often best advised to pay a good price - even a premium - to buy out the other shareholder, and to get on with the business of building a business. The minority shareholder is best advised to agree to a buyout, even if top dollar is not paid. Often the alternative is loss of the business to both parties, due either to some type of dispute, litigation, or just destruction of the business over time due to the conflict over management.

The "minority shareholder" can be a 49% or a 5% owner. The dollar amount of actual investment, the value of stock, and percentage ownership interests may affect the nature and extent of the feelings of the parties, but some of the above will usually fit.

If the circumstances involve strong personalities, powerful persons (due to wealth or influence), or if other shareholders are family members, some of the feelings may be very strong even if the values, dollar amounts, or percentages of ownership are not great. It may be that the majority owner, with more than 50% of the stock, feels like the abused minority shareholder.

Copyright 2000 Mary Hanson. All rights reserved.

Mary Hanson, MBA, Attorney at Law (310) 543-1355 Torrance (Los Angeles County), California USA