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Shareholder Oppression Remedies Are No Substitute for Control

The difference between owning 50% of your company and owning 51% is great.  But the difference between owning 50% and owning 49% could be catastrophic, despite the significant remedies available to oppressed minority shareholders in New Jersey.

After reading the other articles on this site, one comes away knowing that minority owners have significant rights in New Jersey (at least, that was my goal).  A shareholder who is taken advantage of by majority owners can file an action for damages and various other remedies, including a potential buyout of his shares.  However, such an action is expensive, time consuming, disruptive to the business, and should only be resorted to when all other options have been exhausted.  There is simply no substitute for retaining a majority, or at least a 50% interest, in your own company.

This advice may seem obvious, but it is amazing how many business owners bring in investors, giving up shares in their company (sometimes even a controlling interest), without thoroughly exploring whether there was any way they could arrange for bank financing.  Whether it’s because the owners do not want to pay anything other than the lowest interest rate available, or because they don’t want a bank to know all of their business, the reasons behind this reticence to become beholden to a bank is not uncommon.  Sometimes, a company truly cannot get a bank loan.  However, resorting to alternate methods to raise capital can have dire consequences.

In one company, the founding shareholders owned 60% and 40%, respectively.  The majority owner gave away a 5% interest to three separate investors (15% in total), reducing his interest to 45%, but raising almost $1 million for the company in the process.  He thought that he had a responsibility to “his company” to do this, even though the 40% shareholder refused to give up a single share. The former majority shareholder believed he was protected because he remained the single largest shareholder.  Plus, he took a long-term note back for the value of the shares that he “sold,” so that he would be repaid years down the road, when the company was sold.

Of course, it is obvious where this story is going – at least on this website.  Once the new shareholders “ganged up” on him with the 40% owner, and he was outvoted 55%-45%, his world had changed.  He could no longer dictate the direction of the company that he had run for years.  Nor could he set his own compensation.  At first, he was a minority shareholder without a remedy, because not everything that majority shareholders do that the minority disagrees with is actionable.  And when the new majority coalition finally went too far and engaged in action that he could sue over, it was hardly a day to celebrate.  An unceremonious firing, followed by two years of litigation, led to a multi-million dollar buyout that certainly did not leave him destitute.  However, while he may be a rich man today, he would much rather have remained in charge of his “own” company, with the opportunity to see what it could have achieved under his stewardship.

The worst part is, when I asked him why he didn’t just borrow the money the company needed from the bank, he confided that the interest rate was too high.  Well, at least he saved that.

The point is, while minority shareholders (and now, LLC members) do have significant rights in New Jersey, those rights are no substitute for control.  So, if you ever find yourself on Shark Tank, don’t take the money, unless you deparately need it and have no other alternative, if the “Shark” is asking for 51% of your company.  It will probably turn out worse than you can imagine.