Sometimes it seems the best strategy for your business is to bring in an investor with a minority interest. Perhaps the investor provides much-needed capital or a service you want to keep. But giving up interest in your company – even a non-controlling share – can be difficult.
As I’ve covered in a previous blog, under the law, the minority investor typically is a fiduciary duty. The managers who control the business must do so in a way that is best for all the owners. If the majority and minority owner disagree about the business, a lawsuit is a looming possibility. How do we manage this risk? Let’s look at three ways to keep an investor with a minority interest from becoming a real fly in the ointment.
#1. You want a clear contract or agreement about what that investment looks like and what rights the investor has and doesn’t have. This may include modifying the fiduciary duties. In many states, you can modify the fiduciary duties that the managers owe to the investors. This may be a strategy to minimize the risk of lawsuits. You want to have a very clear understanding.
#2. You want a contract with employees or service providers who receive equity in the company. To the extent that they come in as owners of the company, you want to document what that ownership looks like, how it works and what’s required. You usually don’t want to do an outright grant of ownership. You want to grant the ownership so that it is earned over time or certain conditions are met. I’ve seen horror stories where business owners have given away ownership, and then the person stopped performing or walked away. Make sure the equity granted is fully-earned, especially if future service is involved. Structure the business accordingly and have the correct contracts.
#3. You want to structure your management correctly. Who’s managing? Who’s responsible for what? What risks are involved? This is another area where you may want to adjust the management structure or deal with fiduciary duty issues to make sure that we understand what our risks are, and how things are being processed in the business.
Despite the risks with minority shareholders, they can be great. They can provide insight or capital to help the business get to where it needs to go. But we don’t want a short-term need early in the life of the business to cause a long-term problem. That’s why some smart thinking about the rights and responsibilities of a minority investor can make a huge difference.
What are your thoughts on this? Have you negotiated a minority investment in your company? How did it work? Join us in the comments below and let us know your thoughts and experience.
Each case is unique. Past results do not guarantee future outcomes. This posting is intended to be a tool to familiarize readers with some of the issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. Each case is unique. Past results do not guarantee future outcomes. This article should not be treated as legal advice to any person or entity. FreeImages.com/photographer Kent Squires.
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