Q: How do I address dissenting non-majority shareholders who disrupt operations and threaten litigation if I don’t buy them out at an inflated price?
A: When you hold shares in a publicly traded company, you are free to sell those shares on the open market. But that luxury is not available for “closely held” businesses, where disputes can more easily become detrimental to operations.
Luckily for the majority (i.e. controlling) shareholder or shareholders, that dissent should not disrupt operations during the ordinary course of prudent business because the minority is simply outvoted. But minority shareholders can shake things up when, for example, the company is going through a merger or sale of business assets, the controlling shareholders are acting illegally or wastefully, or a deadlock in voting occurs. The first of these three scenarios can give rise to the right to be bought out, whereas the remaining scenarios give rise to the more dangerous remedy of dissolving the corporation. If a dissenter seeks to dissolve, the lifeline for those who remain in control is to elect to purchase the shares of the dissenting shareholders at fair value.
With regard to the right to be bought out (“dissenters’ rights”), as to closely held corporations of 10 or fewer shareholders, the dissenter often obtains payment based on an appraisal and his share of the company.
For example, a shareholder who owns 30 percent of the corporation, or 30 of the 100 shares, would be entitled to $30,000 if the appraised value of the business is $100,000. Generally, this would be the maximum the minority shareholder could receive absent a court determining that misconduct by the controlling shareholders would dictate greater compensation.
The reality is that 30 percent of the shares of a company are usually worth less than 30 percent of the appraised value of the company, at least to an outsider. If you were to buy into a company for 30 percent, you receive a right to profit distributions but no control over the direction of the business. Buying 51 percent is often substantially more valuable than buying 49 percent because of control.
Also, shares in closely held corporations typically face a much more limited market of buyers than shares in publicly traded companies.For that reason, should the dissenters suffer a discount for lack of control and marketability when being bought out? For the specific dissenters-rights scenario above (with 10 or fewer shareholders), a Florida statute prohibits such discounts. But the discounts are at least arguably available for corporations with more shareholders or in the dissolution context mentioned at the end of the first paragraph.
There are a number of ways to value a business, including by looking at the total value of the assets of the business or by applying a multiplier to the earnings or earning potential of the business. The applicable method varies greatly depending on the circumstances.
The tips above will assist in negotiating with dissenting shareholders and in determining the likely outcome of litigation. If negotiation is unsuccessful and your business faces uncontrolled disruption, taking control by pursuing remedies in court with the advice of counsel may be the next step.
Published as part of my law firm’s biweekly column in The Ledger here.