Minority shareholder protection

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Minority shareholder protection

A Hong Kong resident investor required minority shareholder protection. Two former colleagues, now based in the UK, wanted him to invest £100,000.00 in what seemed like an excellent business idea.

Our client, the Hong Kong resident, was enthusiastic but concerned about the terms and conditions of the investment. He engaged us to explain the risks and confirm that the documents represented standard practice in the UK.

Minority shareholder problems

Investors usually hold a minority stake in a business. In this case there were 3 key issues:

  1. Can the investment be diluted?
  2. Can the investor ensure their investment is wisely spent?
  3. Are there any risks that the investor’s liability is greater than the amount paid for the shares?

Minority shareholder protection

Our answers to these questions were:

  1. To protect against dilution it is important that any documents contain pre-emption rights. These give a right of first refusal to existing shareholders prior to any new shareholders being issued shares. Pre-emption rights are often contained in the articles, or a shareholders’ agreement. Off the shelf documents will not give the right protection.
  2. To ensure their investment is wisely managed, a minority shareholder should require veto rights over certain business decisions, e.g. pay rises for any founder, shareholder or director.

Drag-along rights

In addition there are, perhaps surprisingly, circumstances where the investor’s liability exceeds their investment. One example is a sale where there is joint and several liability. The proposed documentation contained a drag-along right. A drag-along right would require the investor to join in any sale on the same terms and conditions as all sellers.

In addition, there was a provision that all parties would agree the terms of sale agreed by the majority shareholders. This means that on a future business sale the minority investor could face joint and several liability for a breach of warranty claim that far exceeded his initial investment.

Addressing investment risks

Of course, with any investment there are no certainties that the business will increase in value. Nevertheless it is important for an investor to be well-protected. We ensured there are no circumstances where our client’s liability could be greater than his initial investment. That was out client’s concern.

John Deane is a partner in the commercial team at Gannons. John acts for individual investors, as well as the companies seeking investment. Experience helps streamline the process. Please do not hesitate to get in touch with John if we can be of assistance.