Lifecycle of a Business - Protections for Minority Shareholders

Setting up and running your own business is an amazing achievement. It requires vision, creativity, motivation and stamina. On occasion, it can even bring you fame, riches and fortune. But it can also result in reams of paperwork and cause sleepless nights. And as someone once said to me about children “It doesn’t get easier, it just changes”, so the same can be said for your business throughout its lifecycle. From setting up to exit, it will force you to consider issues that you might not previously have known anything about and it will need you to make many decisions, sometimes very quickly. What it certainly is not is mundane.

With this in mind, the corporate team at Forsters, together with some of our specialist colleagues, has written a series of articles about the various issues and some of the key points that it may help you to know about at each stage of a business’s life. Not all of these will be relevant to you or your business endeavours, but we hope that you will find at least some of these guides interesting and useful, whether you just have the glimmer of an idea, are a start-up, a well-established enterprise or are considering your exit options. Do feel free to drop us a line or pick up the phone if you would like to discuss any of the issues raised further.

So far, we’ve covered initial considerations, directors and funding, so now let’s have a think about “Shareholders”.

Protections for Minority Shareholders

Minority shareholders are those who cannot, by themselves, control the direction a company will take and, as a result, may be adversely affected by decisions made by the majority shareholder(s). This article sets out some of the rights a minority shareholder may seek in a private limited company in England and Wales and those provisions that majority shareholders can expect their minority shareholders to raise.

Legislation

Legislation offers certain limited protections for minority shareholders, some of which were mentioned in our last article, ‘What are your rights as a shareholder?’. In addition to the points mentioned in that article:

1. a shareholder can block special resolutions where they, either by themselves or with other shareholders, hold more than 25% of the voting shares in the company. This can stop key matters passing, such as changing the company’s articles of association;
2. a shareholder can cause a general meeting of the shareholders to be called where they, either by themselves or with other shareholders, hold at least 5% of the paid-up shares that have the right to vote. Alternatively, those shareholders with 5% of the voting rights can arrange for a written resolution to be circulated. Either action will enable the shareholder(s) to put matters in front of the other shareholders for them to vote on;
3. any shareholder can bring a claim for unfair prejudice against the company (where actions have been, or are being, taken that are, or would be, unfairly prejudicial to the shareholders, or some of them), although it should be noted that a common outcome of this process is that the court orders the majority shareholder to buy out the minority shareholder;
4. any shareholder can bring a derivative action against a director for actions such as negligence, default, breach of duty or a breach of trust. However, bear in mind that this is an action brought in the name of the company and so any damages recovered would not go to the shareholder; and
5. in certain qualifying cases, where a shareholder has held their shares for at least six of the preceding 18 months, they can apply to the court for the winding-up of the company, although it should be noted that the bar for success with this route is high.

Given the limited nature of the statutory protections on offer, minority shareholders often seek to negotiate contractual minority protections at the outset of their investment.

Contractual Protections

Contractual protections are usually found in the company’s articles of association and any shareholders’ agreement or investment agreement (which governs the relationship between the shareholders of a company) that is in place. They can include the following (subject to the specific requirements of the transaction and negotiations):

1. Reserved Matters: A majority shareholder may agree a list of matters which the company cannot carry out without the consent of the minority shareholder(s). These are usually the most important matters relating to the company which would affect a minority shareholder’s position, such as changes being made to the company’s articles of association, the taking out of a substantial loan by the company, the entry into significant contracts by it or the winding-up of the company.
2. Pre-Emption (Share Issue): Pre-emption rights on an issue of shares by the company enable a minority shareholder to avoid their shareholding being diluted by the future issue of new shares to third parties (or other shareholders), by giving the minority shareholder a right of first refusal to take up any of the new shares, usually in proportion to their shareholding at the time of issue. If a contractual protection is not included, and reliance is instead placed on the statutory pre-emption right, those holding 75% of the voting shares in the company can disapply the provision. That said, the purchase price for a minority stake can be substantial.
3. Pre-Emption (Share Transfer): Similarly, pre-emption rights can be included in respect of a transfer of shares, giving the minority shareholder a right to purchase certain of the shares of an outgoing shareholder, usually in proportion to the shares the minority shareholder already holds in the company. However, this can again be a costly process and the minority shareholder will need to ensure they have the funds to purchase the shares.
4. Board of Directors: A minority shareholder can, if its minority shareholding is appropriately significant (usually by reference to a percentage shareholding), request the right to appoint a director to the board and for that person to be present in order for any meeting to be quorate. If they are not able to obtain this right, they may be able to appoint an observer at board meetings so that they are aware of matters discussed by the board, albeit without having the voting rights that come with being a director.
5. Exit Right: Tag-along rights provide an exit route for minority shareholders where there will be a change of control of the company. Here, they are able to sell their shares to the same purchaser of the majority shareholder’s shares and on the same terms. This ensures that a consistent value is paid for the shares in the company and avoids the minority shareholder(s) being left in the business with a new party. Additionally, a minority shareholder may seek to include a put option, to ensure that if a dispute arises between the shareholders, for example, they will receive an agreed value for their shares or have a mechanism in place for an independent third party to confirm the value.
6. Information Rights: In addition to the statutory right to see certain company information, such as the company’s annual accounts and directors’ report, a minority shareholder may be able to obtain management reports throughout the year as a means of monitoring their investment in, and the performance of, the company.
7. Dividend Policy: Having a clear dividend policy in place will help to give certainty to a minority shareholder as to when they are likely to receive a dividend from the company in respect of their investment. Without this, minority shareholders are unable to pass or block an ordinary resolution to declare dividends.
8. Business Plan: In a joint venture scenario, a minority shareholder is likely to want to have a say in the signing-off of the annual business plan of the company, to ensure that the commercial objectives of the parties are clearly aligned.

Protections of this nature have been in the news recently with Sir Jim Ratcliffe’s investment into Manchester United. It is reported that he will have a right of first refusal for a year if the Glazer family sell their shares, but the Glazer family will be able to drag-along Sir Jim Ratcliffe if there is a full sale of the club after 18 months of the completion of his investment and provided that he receives at least $33 per share.

Conclusion

If you are a minority shareholder investing in a company, or a majority shareholder who has received a request for protections from an incoming investor, please do not hesitate to get in touch with a member of our Corporate team, who will be happy to assist you.

Disclaimer

This note reflects the law as at 2 February 2024. The circumstances of each case vary and this note should not be relied upon in place of specific legal advice.