Before you become a “minority” owner of a business, here’s what to consider…
A business is “closely-held” when ownership is severely limited and those limitations extend to an owner’s ability to withdraw their investment and “retire”. A “minority owner” owns less than 50% of a business or investment. This article is for anyone considering becoming a minority owner in a business or in an investment (e.g. vacant land) that is closely-held, with particular focus on closely-held businesses operating as a limited liability company (“LLC”) under Florida law and formed to hold a significant asset such as commercial real estate.
Becoming a minority owner may allow you to help a business grow and share in its success without the management responsibilities. Minority owners are sought for help with growth, to acquire other business assets, or provide business or professional knowledge in addition to a capital injection in the business.
Florida law provides minority owners with limited rights. A minority owner may be at the mercy of the majority owners. If conflict arises and a minority owner’s rights are infringed, while litigation may be an option, it is an option of last resort given the cost litigation brings in added stress and lost time and money. Conflicts can be prevented or significantly reduced through a written agreement that goes beyond Florida law to protect the minority owner against oppressive conduct by the majority owner(s) of the business.
Minority Owner Rights
Most businesses and groups of investors have a few private owners and do not publicly issue ownership interests. These closely-held businesses and investments can be operated as corporations, partnerships, or LLCs. A potential minority owner, for example, might invest $50,000 in a company in exchange for a 20% ownership interest. Because a minority owner does not have a controlling stake in the business, they have fewer rights than majority owners.
Generally, absent a written agreement that expands their rights, a minority owner is only entitled to:
- The right to vote on certain matters, such as electing the board of directors for a corporation or the manager for an LLC;
- The right to inspect company books and financial records;
- The right to receive dividends or distributions from the business if there is a distribution of profits and to receive part of the net proceeds from the sale or dissolution of the business; and
- The right to sue majority owners for breach of fiduciary duty.
Outside of these basic rights, minority owners may find that, regardless of their investment in the closely-held company, they have little or no ability to control the direction of the company and no right to participate in daily decisions. If a minority owner is also a company employee, they do not have the right to continued employment if they are fired. They also lack the right to demand distributions if the majority owner does not make them.
Enforcement of Minority Rights
The rights of a minority owner, while limited, can be enforced based on Florida laws that provide protections aimed at preventing minority owner oppression. Although majority owners have wide discretion over how to run the company, they still have business and legal responsibilities to the interests of the company and all of its owners including the minority owners. Depending on a state’s law, the majority owner may owe fiduciary duties only to the company and not to a minority owner.
Under Florida law, in addition to the duty of care, LLC members or managers also owe the duty of loyalty to the LLC and its members. A member or manager is supposed to put the success and benefits of the LLC above any individual advantages. In showing loyalty to the LLC, a fiduciary must avoid any conflicts of interest between the LLC’s goals and their own personal aspirations.
Minority oppression may occur in situations such as:
- The majority owner refuses to make profit distributions when the company is profitable;
- The majority owners are excessively compensated;
- The majority owners dilute the voting rights or ownership of minority owners;
- The majority owners unreasonably restrict the sale or transfer of minority membership interests;
- The majority owners deny a minority owner’s access to financial records; and
- The minority owner is fired as a “squeeze play” to eliminate their ownership interest.
Not all of these examples will rise to the level of oppression. A successful oppression lawsuit may result in the payment of monetary damages, a court-ordered buyout of the oppressed minority owner, or equitable relief, such as requiring the company to stop their specific oppressive actions.
Florida law applicable to ownership disagreements include the Florida Revised Limited Liability Company Act (Florida Statutes, Chapter 605) and the Florida Business Corporation Act (Florida Statutes, Chapter 607).
Negotiating Stronger Minority Owner Protections
A minority owner may only have their eyes on financial gain, but that objective can be in jeopardy if the majority owners spend and reinvest money inconsistent with an agreement that calls for some of the profit to be distributed to the minority owner. A distribution resulting from a business sale cannot be guaranteed to a minority owner, if the sale is structured to limit the minority owner payouts. Minority owners cannot count on the ability to sell their ownership interest if the closely-held nature of the business or investment is such that there is no market for their minority interest to be purchased. When a minority owner wants to do estate planning, they may find that unless an agreement allows for a transfer, they cannot freely transfer their minority interest to a family member.
However, minority owners need not accept the limited rights they have under Florida law. For example, an LLC formed to run a business or invest in real estate can have an operating agreement and a buy-sell agreement that include provisions to help to protect minority owners.
Before obtaining a minority stake in a business or investment, prospective owners will want to consider their expectations about these issues:
- Level of involvement in day-to-day management of the business or investment;
- Decision-making authority regarding company changes, including the sale of the business or a merger or acquisition;
- Equity payments from company operations;
- The ability to sell an ownership interest or be bought out by the other owners;
- Distributions from the sale or dissolution of the company; and
- What the surviving members and the company must do if an owner dies or becomes mentally incapacitated.
Initial expectations can be set during a discussion between business partners, but handshake agreements do not go far enough. The agreed-upon understanding between the minority and majority owners should be in a written agreement, signed by all members of the company and its managers or officers. Absent a written agreement that solidifies their rights, many minority owners are left relying on the majority owners’ good faith. Should that faith prove misplaced, a minority owner may realize—albeit too late—how vulnerable they are to the majority.
Protect Yourself as a Minority Business Owner
Trust is important, but trust should be backed by a written agreement. Remember the maxim, “Trust but verify”. Some issues may not be expected until they arise. Others can leave you grasping at legal straws. As a minority owner, you need not accept the limited protections that Florida law offers and you are encouraged to negotiate favorable terms as a condition of taking on a minority owner role.
Before investing your time and money in a business venture or investment, it is prudent to consult an attorney. We can help you solidify your expectations with legally enforceable agreements. If you already have agreements in place, we can also advise on what, if anything, you may want to change in the agreement to enhance your rights as a minority owner. To discuss your concerns, please contact our office at (813) 852-6500 and schedule an appointment.