Making a minority investment in a company can be financially rewarding if timed well but doing so is not without risk. A minority investor will typically have limited control over the management of the company and have no liquid market to sell its shares should it wish to exit. Whether a sophisticated venture capital firm or a high net worth individual, an investor should seek certain rights and protections to safeguard its investment. Minority shareholder rights under a company's constitution are typically limited, so a shareholders agreement incorporating express contractual rights above and beyond those afforded by Irish statute should be executed. Our advisory provides a short overview of these key protections for minority investors.
Anti-dilution
A minority investor which invests at an early stage should ensure that its shareholding is not improperly diluted by latecomers. Protection from anti-dilution due to a subsequent issue of shares or other equity interests such as warrants, convertible loan notes or share options, at a price below the price the minority investor paid for its shares, should be sought. This can be achieved by way of price-based anti-dilution protection, where the company may not issue equity interests at a purchase price less than that paid by the initial investor or by the initial investor receiving further shares either by way of bonus issue at nominal value or by subscription at par value.
Board Participation
Whilst shareholders own a company, the directors have day-to-day control. Minority investors are unlikely to be able to control the board, however, depending on their negotiating power, they may be able to appoint a director affording it the ability to influence key decisions. Directors have fiduciary duties so with the absence of a robust D&O insurance policy, mere observer status might be a preferred alternative.
Pre-emption Rights
Minority investors may insist on the ability to 'follow their money'. Unless dis-applied, shareholders in an Irish company have a right of pre-emption when shares are allotted to any new shareholder. This effectively means the existing shareholders are granted first refusal over any new shares being issued so as to maintain their current shareholding level in the company. These provisions are often dis-applied by the company's constitution so appropriate pre-emption provisions should be set out in any shareholders' agreement.
Right of First Refusal
A minority investor should look for the right of first refusal upon any proposed transfer of shares and seek to have the opportunity to increase its position if desired, especially if they would prefer not to be in business with the proposed third-party purchaser.
Call for Departing Founder/Employees' Shares
A minority investor who is not a founder or employee of the company may seek to ensure that the company has the right to acquire any departing founder or employee shares, whether departing voluntarily or not. Typically the price paid by the company for such shares will depend on the timing of and the reasons for such departure.
Supramajority Voting or Consent Rights
Irrespective of whether a minority investor succeeds in having board representation, a minority investor should insist on certain significant matters requiring its consent, or at the very least, requiring supramajority voting. Such actions would typically include changing the nature of the business, share capital changes, a sale of the company or sale/acquisition of a material asset, commencing any equity or debt transaction, starting or settling litigation, approving distributions, entering into transactions with connected parties, increasing any share option pool, changing senior executive compensation, hiring or firing key personnel or dissolving the company.
While having a lengthy list of matters requiring its consent might appear reassuring to a minority investor, a balance should be struck to ensure the minority investor is adequately protected but not overly burdened by continuous requests for consent for immaterial or ordinary course matters. Where appropriate, these consent rights would typically be subject to agreed materiality thresholds. Numerous consent rights also increase the risk of deadlock when shareholders cannot agree on a matter requiring consent and deadlock is rarely in the interests of the company or its shareholders.
Information/Access Rights
It is essential that a minority investor has sight of the financial information related to the company in order to monitor the performance of its investment. Controlling shareholders and directors will rarely voluntarily disclose information so a minority investor should seek a contractual right to access relevant financial information, including internal management accounts, review the company's books and records and receive financial statements and the operating budget/business plan on a periodic basis.
Drag-Along Rights
Drag-along rights are provisions that make it mandatory for a minority shareholder to agree and join the majority shareholders in the sale of a company. In effect, the minority shareholder is "dragged along" and the majority shareholder who is "dragging" the other shareholders must offer the minority shareholders the same price, terms and conditions that the majority shareholder has been offered. While dragalong rights are typically favoured towards majority shareholders in order to prevent a minority shareholder blocking the sale of a majority shareholders shares, such rights are beneficial to minority shareholders as they allow the minority shareholder to be treated the same as the majority shareholder. If a minority shareholder is to receive private securities as payment, it should ensure such securities also provide for minimum investor rights.
Tag-Along Rights
Tag-along rights, also known as 'co-sale rights', allow a minority shareholder to participate in any sale of shares in the company by a majority shareholder on the same terms. Such rights are designed to protect the minority shareholders from being left behind with a potentially unfavourable new shareholder and effectively oblige the majority shareholder to include the shareholdings of the minority shareholder in any negotiations. Tag-along provisions are typically drafted so that if the tag-along procedures are not followed then any attempt to buy shares in the company are invalid and cannot be registered.
Put Right/Shotgun Clause
In large companies with shares traded on a public stock exchange, investors can easily sell their shares. However, shareholders in privately held close companies (where shares are owned by a small number of persons) cannot as readily sell their shares should they wish. Although not granted to every minority investor, there are protections that might facilitate a minority investor exit.
A put option would require either the company or other shareholders to buy out the minority investor in specific situations such as a failure to meet financial targets or the departure of essential personnel.
In a similar vein, a "shotgun" clause provides an investor with the right to buy shares or sell shares to another shareholder when a material dispute arises regarding the operation of the company.
Conclusion
A minority investor may not succeed in obtaining all of the protections outlined here. The level of concessions obtained from the company will depend on the transaction at hand and the leverage of the parties. However, these protections, while not exhaustive, are some of the more critical considerations for minority investors and should at the very least be considered and explored with the company when thinking of investing. In any event, it is imperative that a comprehensive shareholders agreement is negotiated and executed to ensure a minority investor has the best protection available should plans go awry.
Legal advice should be sought prior to making any investment to ensure adequate protections are obtained.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
