You’re a businessman who’ve poured years into building your own small business. Finding yourself short of needed funds, you decide to bring on some shareholders. So you do just that; reaching out into your community, you bring on a new minority shareholder to get cash flowing. Years pass uneventfully. Then, you and the minority shareholder have a falling out. You want to find some way to divorce him from the company, but are concerned that you might not be able to legally (he is an owner after all). Unfortunately for you, without planning ahead, you could be in for a costly legal fight, and you might lose. So, how do you plan ahead so you can regain control without spiraling into a costly legal fight?
The answer is a shareholder agreement. Without clear rules, minority shareholders can stall decisions or refuse to sell their shares, threatening your company’s future. A shareholder agreement is your shield, empowering majority owners to reclaim ownership through pre-planned buyouts or exit strategies. In this post, we’ll explore why this agreement is essential and share practical steps to protect your business.
Why Minority Shareholders Can Derail Your Business
Minority shareholders—those owning less than 50% of a company—can wield surprising power. They might refuse to cooperate on key decisions, demand excessive dividends, or refuse to sell shares during a sale, stalling your business’ growth and limiting your ownership. For example, picture a Raleigh software startup where a minority investor blocks lucrative acquisition, leaving majority owners frustrated. The source of the problem is that minority shareholders possess certain rights and powers ex officio, and that controlling shareholders are restricted in their exercise of power by duties to the minority shareholders.
Minority shareholders have certain rights and powers by virtue of their ownership interest. First, these shareholders often have a right to vote their shares to elect directors, or govern material changes in the corporation (e.g., dissolving the company, amending the bylaws and/or articles of incorporation, etc.). N.C. Gen. Stat. §§ 55-14-02, 55-10-03. However, “non-voting” shares lack this power. N.C. Gen. Stat. § 55-7-21. Second, shareholders can dissent from certain corporate acts, such as mergers, asset sales, and amendments affecting their shares. N.C. Gen. Stat. § 55-13-03. In doing so, a shareholder can demand his shares be bought back by the corporation. Id. Third, in small corporations (< 25 shareholders), those owning 20% or more of shares can demand one-third of net profits as a dividend, subject to conditions. N.C. Gen. Stat. § 55-6-40(i). Fourth, shareholders can sue on behalf of the corporation—a derivative action. N.C. Gen. Stat. 55-7-42. Sixth, Shareholders owning more than 5% can inspect corporate records with a proper purpose. N.C. Gen. Stat. § 55-16-02. Even non-qualified shareholders can inspect certain documents. Id. Seventh, shareholders can sue to dissolve a corporation under certain conditions, including management deadlock, asset misuse, or violation of their rights. N.C. Gen. Stat. § 55-14-30(2). A corporation can prevent dissolution by buying out the minority shareholder(s). N.C. Gen. Stat. § 55-14-31(d). Finally, upon dissolution, shareholders receive remaining assets after creditors are paid, based on ownership share. N.C. Gen. Stat. § 55-14-05.
At the same time, minority shareholders’ rights are heavily protected by duties owed from the controlling shareholders, officers, and directors. North Carolina’s courts have long recognized that controlling shareholders owe fiduciary duties to minority shareholders, distinct from officers’ and directors’ duties. See, e.g., Loy v. Lorm Corp., 52 N.C. App. 428, 432, 278 S.E.2d 897, 901 (1981). Accordingly, they must act in good faith, avoiding self-dealing at the minority’s expense. Id. This same duty carries over to officers and directors, who owe a duty of good faith to the corporation. N.C. Gen. Stat. § 55-8-30.
Ask yourself: Could a minority shareholder disrupt your business by possessing these rights? Closely held corporations face an ever-present risk of these conflicts. Without prudent planning, a falling out between controlling and minority shareholders could cost a company millions. So, how do you prevent these disputes? Perhaps the best option is a shareholder agreement.
Your Tool for Control: The Shareholder Agreement
A shareholder agreement is a binding contract among a company’s shareholders, outlining their rights, responsibilities, and exit strategies. It governs the relationship between shareholders and the company, guaranteeing clarity for all parties involved. Think of it as a rulebook for your business, preventing conflicts before they start. These agreements empower majority owners to clarify decision-making (e.g., who controls major votes), restrict share transfers (e.g., preventing sales to outsiders), and reclaim ownership through buyout clauses. Key components also often include mediation clauses, as well as non-compete or confidentiality clauses to protect corporate interests.
Provisions like buy-sell agreements (governing what happens to a party’s shares if they leave the company) or drag-along rights (forcing the minority to sell their shares if the majority decides to sell the company) enable majority owners to repurchase minority shares amid disputes or company sales. North Carolina law enforces reasonable shareholder agreements, but they should be precise to avoid ambiguity. See N.C. Gen. Stat. § 55-7-31.
A strong shareholder agreement anticipates disputes and provides clear solutions. Here’s a checklist of provisions every business owner should consider:
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- Non-compete or confidentiality clauses to protect corporate interests
- Buy-Sell Provisions: Define when majority owners can buy out minority shares (e.g., during deadlocks or exits) and how shares are valued (e.g., fair market value) in the event of such a sale.
- Right of First Refusal: Require minority shareholders to offer shares to existing owners before selling to outsiders.
- Drag-Along Rights: Allow majority owners to force minority shareholders to join a company sale.
- Redemption Rights: Allows the company to repurchase minority shares at set intervals or on triggering events.
- Voting Agreements: Specify who controls key decisions to prevent minority obstruction on key issues.
- Dispute Resolution: Include mediation or arbitration clauses to avoid costly lawsuits.
Without an agreement, you’re gambling with your company’s future. If a minority shareholder refuses to cooperate in major business decisions, you need a means to continue corporate functioning.
Conclusion
Minority shareholder disputes can jeopardize your business, but a shareholder agreement is your key to reclaiming ownership and maintaining control. By including provisions like buy-sell clauses and dispute resolution mechanisms, you can prevent conflicts and protect your company’s future.
Disclaimer
This post is for informational purposes and not legal advice. Consult an attorney for your specific situation.