1. Protections for Minority Investors
2. Why Make a Minority Investment?
3. Planning Is Important

Minority investors have a minority interest in a company. A minority interest is a percentage of ownership that's significant but doesn't give the holder the right to control the company.

Usually, only the dividends from a minority interest are included on a corporate balance sheet. If the owner has enough shares to influence the company's direction, ordinary income is part of the balance sheet as well. To a parent company, a minority interest is a liability on a balance sheet that indicates the percentage of a subsidiary that the parent company doesn't own, or the portion that's publicly traded.

Protections for Minority Investors

When minority investors take on equity in a closely held company, they have limited control over management. They may not be able to sell their shares for a good price if the business fails. Many people ask for substantial protections before investing. Here are some of the most common protections:

  • Board participation, including regular board meetings and approval requirements for significant transactions.
  • Directors and officers liability insurance (D&O).
  • The right to review the company's books, records, and financial statements.
  • Annual approval of an operating budget by the board.
  • The right of first refusal gives existing shareholders the first chance to buy additional shares and increase their control of the company.
  • A Company Call for Departed Employees' Shares gives the business the right to buy back shares from a founder or employee who leaves or is fired. The purchase price is often discounted.
  • Preemptive rights to participate in any subsequent securities offerings
  • Simple co-sale or tag along rights let minority investors participate in sales on the same terms as the selling shareholders. They can sell their shares if they don't want to work with a new shareholder.
  • Drag along payment rights require the minority investor to participate in a sale of the company, but they also guarantee a fair payment.
  • Anti-dilution provisions keep investors' interests from being diluted by new stocks at a lower price. It usually guarantees additional shares for the investor.
  • Supermajority voting or consent rights require more than a simple majority for major decisions, like a merger, an investment by the company in another business, hiring or firing a key employee, or signing a loan.
  • A put right or shotgun clause requires the company or shareholders to buy out the minority investor if the company fails.

Not all companies will offer all of these protections to minority investors. Some minority investors negotiate with companies for additional protective clauses or provisions. This is a great way for both sides to get to know each other.

Why Make a Minority Investment?

Owners often think about bringing on a new investor when they're:

  • Considering transitioning away from the business.
  • Looking for cash for new equipment.
  • Expanding the company or making other upgrades.
  • Attempting to survive challenging conditions.
  • Diversifying their net worth.

A new investor can give a business owner the chance to build a new partnership and provide additional liquidity. Majority shareholders will maintain control over most of the company's important decisions. Minority investments can often:

  • Generate more funds than a leveraged recapitalization.
  • Help preserve company culture.
  • Provide stability.
  • Allow expansion.
  • Bring in shareholders with valuable industry contacts and expertise.

Planning Is Important

Business owners should consider several operational, financial, and legal factors before taking on a minority investor. Many of these variables can affect the value of the business and the ease of a transition dramatically. Fortunately, owners can take a range of actions to make their companies more attractive to potential investors and maximize their profits:

  • Evaluate management strengths and weaknesses and then fill any personnel gaps or identify an action plan.
  • Complete regular financial audits to keep track of how the business is doing.
  • Bring customers and suppliers as close to each other as possible.
  • Look for savings and keep prices low.
  • Diversify revenue or procurement strategies.
  • Define key operating metrics like sales figures and track them regularly.
  • Clean up the balance sheet by eliminating unnecessary expenses, unprofitable agreements, bad debts, and obsolete or unpopular inventory.
  • Identify and evaluate any outstanding litigation or other potential claims.
  • Research strategies to resolve or mitigate uncertainties.

If you need help with minority investors, you can post your legal need or post your job on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.