Minority Shareholder 8 FAQs
Here you can download our How To Protect Minority Shareholder Interests 8 Frequently Asked Questions answered booklet. An example of the useful information you can find in the booklet is featured below.
Limited liability companies with Shareholders are conventionally set up solely for the purpose of running a successful business, generating a profit and at all times acting in the interests of shareholders. Shareholders own the Company but do not generally have any say in how it is run on a day to day basis, other than in respect of structural issues (often referred to as corporate governance) pertaining to who runs it and the business objectives and strategy.
The Company’s business is managed by Directors who have the authority to bind the Company to various transactions and otherwise deal with all operations, sales, financial matters and other parts of the business. Whilst Shareholders have the power to alter the Company’s structure, in which the Directors operate, it is the Directors that ultimately make all the day to day decisions.
However it is often the case, especially within small to medium-sized companies that the Shareholders and the Directors are the same or similar groups of individuals who incorporated the Company with expectations of what each other would do and receive from the Company. As time passes, it is very likely that the Company’s business and their respective Shareholder/Director relationships will develop and sometimes this development is not positive such that one group feels vulnerable to decisions by the other group (or individual) who may seek to control the Company solely in their personal interests.
In this article we attempt to deal with the interests of any Shareholders who hold a Minority share (i.e. 50% or less) in a company and what could be done to protect their interests in this respect.
1. What Control Do Shareholders Have Over Company Decisions?
Generally within standard limited liability companies there are 2 documents which determine the structure of how Directors can operate and what Shareholders rights are.
The first, which is a standard document existing in all companies, is the Articles of Association (“the Articles”). This provides a framework within which the Directors can act, subject to statute, by for example delegating powers to grant security over property, allowing the directors to bind the company into specific transactions and determining how decisions of directors are made.
It can also affect Shareholder interests - such as who is entitled to receive an offer for sale of shares should one shareholder decide to exit (often referred to as “Pre-Emption Rights”).
Another document, which is not often used in a company but which is incredibly useful, is a Shareholders Agreement. This is a specific agreement drawn up between Shareholders at the outset of a business (or perhaps even later on) where they agree what each other will do as Directors in the Company and what their expectations are going forward.
This document can provide a remedy where cases of dispute arise. However it is not a document publicly available at Companies House and will only bind the Shareholders originally party to it. If a new shareholder comes into the Company then s/he may not be bound by that Shareholders Agreement (subject to the provisions of the Shareholders Agreement) and therefore there may be no such protection for any remaining original Shareholders.
2. How Do Shareholders Make Decisions?
Most decisions in the Company are made by Directors but some decisions cannot be made by Directors. One example is the removal of a Director and another maybe a substantial property transaction which involves a connected party, for example selling the main trading premises.
In such circumstance the Shareholders are required to vote on any such proposals. Voting by Shareholders may occur in writing (dependent on when the Company was incorporated under new legislation) or may be by a formal meeting of Shareholders (often referred to as a General Meeting). All Shareholders must receive notice of the General Meeting and in certain circumstances Special Notice is required (28 days).
If these strict requirements are not adhered to then any resolution by Shareholders may not be valid.
Resolutions are generally passed in one of two categories, Ordinary Resolutions (requiring 50% plus of Shareholder votes) or Special Resolutions (requiring above 75% of Shareholders to agree such a proposed resolution). Most decisions are passed by Ordinary Resolution, which requires in excess of a 50% vote by Shareholders to approve it.
3. Where Do Problems Most Commonly Arise?
It is a fact of life that two (or more) people often go into business together with shared objectives and a shared mutual understanding of each other’s role in the Company and at the same time neither wants the other to have more control. Accordingly it is extremely common for each party to assign a 50% Shareholding to the other with the belief that this will mitigate any future problems as nothing can happen without consensus.
Whilst this is a sensible idea, where relationships deteriorate or decisions cannot be made because of disagreement, the resulting circumstances is a Shareholder (and often Director) Deadlock.
Shareholder Deadlock will often pervade through to the Shareholders’ decisions as Directors (unless they have appointed a third Director, which is a wise decision) and may lead to a breakdown of the Company business, by reason of it being unable to function and, in the worst case scenario, the Company ceasing to trade.
Another situation is where new parties join the Company, or perhaps of the two original parties one is putting in more investment, and there is a situation where one holds a smaller interest than the other. This can also be a mechanism for ensuring voting can occur to avoid Shareholder Deadlock (described above). An example may be where one Shareholder/Director owns 60% of the shares and the other owns 40%.
Alternatively you may have a husband and wife relationship where somebody with key skills joins the Company and is granted a small Shareholding (for example 20%) to retain loyalty and his/her involvement in the Company.
In any of these circumstances the Minority Shareholder (be that the historic one or the new entrant) will have little or no ability to control the affairs of the Company as their vote relies on the goodwill of others and may, in the best case scenario, only be required for Special Resolutions (which are rarely required for Company business).
The additional disadvantage of having a Minority Share is that a valuation of that share will not be equal to the relevant percentage of the Company (as a result of the limited voting rights described above).
Problems then occur if the Minority Shareholder’s view on how the business should operate is not listened to or the assets of the Company begin to be removed without his/her authority.
Even when the Minority Shareholder is a Director on the Board, there may be difficulties if there are two or more other Directors (as the majority always determines the Company’s vote in board meetings) and even where that Minority Shareholder may only be matched against one other Director (for example where only two Directors exist and there is Deadlock), a simple Shareholders General Meeting can remove the Minority Shareholder from his position as Director by reason of the requirement for an above 50% vote by Shareholders to remove a Director.
4. How Do I Protect My Minority Interest?
The protection of a Minority interest is very difficult despite the fact that Directors always hold a duty of trust and confidence in respect of all the Shareholder’s interests.
Essentially, a Company should be run with Directors acting in all Shareholders’ interests and there should be no need to seek to protect Minority Shareholders as the Directors should also act in their interests. However in reality this is unlikely and the best way to protect a Minority Shareholder’s interest is to ensure a Shareholders Agreement exists or is drafted for the Company’s Shareholders.
A Shareholders Agreement may dictate additional rights that Minority Shareholders may have, remedies they may seek and resolutions if they want to exit the company. A Shareholders Agreement is an extremely valuable document but will not be registered at Companies House and therefore, once executed, should be kept in a secure location (usually with your Solicitor) to enable you to call upon it or refer to it at a later date.
IN ORDER TO FIND OUT MORE ABOUT THIS SUBJECT AND THE ANSWERS TO THE QUESTIONS LISTED BELOW, DOWNLOAD OUR HANDY TIPS BOOKLET HERE.
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