But what happens when the firm’s founder finds themselves as a minority shareholder of the company they built? Or the investor waiting for a big payout discovers the corporate raider is paying a premium price to acquire only enough shares to gain control?
There are usually three primary ways of getting control of a company. First, you can own a controlling interest – 51 per cent of the outstanding shares. Then anything decided on the vote of the majority goes your way. Second, you might not own the majority of shares, but you control the board with a majority of the members voting your way. Here the board determines policy. Third, you might not own a majority of shares, but you control a majority of shareholder votes. This may occur when a company has dual classes of shares, some holding greater voting rights or including a class of share without voting rights.
Control is the desired outcome. If a company is taken private and 100 per cent of the shares have been purchased, the new owner has legitimate control. We enter a grey area when someone owns a majority (51 per cent or more) and exerts control without owning all the shares. Then the majority owner is controlling the minority shareholders investment without having to buy it outright.
So who are these minority shareholders? They could be ordinary investors who buy small positions hoping the stock will rise; company founders who sold to a larger firm and retain some ownership, but not majority control; foreign investors in a domestic company subject to the laws of that country; or shareholders retaining shares in a firm after the majority of shares have been acquired in a takeover.
Smaller shareholders in listed, heavily traded companies usually understand they own a very small part of a very large firm, yet they may still want their voices heard and opinions respected. Problems can develop in the following ways:
* With thinly traded public firms, where the minority shareholder might find it difficult to sell at fair market value if they want to walk away.
* When a company takeover occurs in two steps, the first involving the acquisition of enough shares to gain control and the second buying out the remaining minority shareholders at an unattractive price.
* When majority shareholders and directors consider the company a personal piggy bank, draining the firm of assets and eventually pushing the firm into bankruptcy, depriving minority shareholders of the value of their investment.
Like most systems, unregulated capitalism can develop problems when taken to extremes. Back in the 1880s, the term ‘robber baron’ was coined in the US to describe people who amassed wealth by using controversial techniques, such as unauthorised stock releases or ‘watering stock’. The watered stock technique was used by Daniel Drew in manipulation of Erie Railroad stock in the 1870s. Russian oligarchs found illicit stock manipulation worked well in the 1990s.
An Indonesian mining company offers a contemporary example. Institutional investors bought the company and it became part of a larger one. Ordinary investors found themselves in a vehicle 43 per cent controlled by a major shareholder. Shares worth £14 in May 2011 were recently trading at 203 pence.
Eurasian Natural Resources Corp (ENRC) was taken private by its three founding Kazakh shareholders, who controlled 44 per cent of the equity. The public offering of shares that took place in December 2007 saw the company valued at roughly twice the £3bn they spent to take the company private earlier in 2013. A share worth 540 pence on the offering was worth 217 pence in 2013. Free float, or the number of shares trading in the market was one of several outstanding issues. Would you have wanted to be a minority shareholder in the business?
Majority rule makes sense. It is a principle of democracy. The party with the most votes wins. Problems develop when writing rules to empower minority shareholders. The Financial Conduct Authority realises minority protection cannot become minority control because it dilutes the principle of majority rule.
One solution is to prevent companies from appointing independent directors without the approval of minority investors. Another is giving independent shareholders a veto over transactions between companies and the controlling shareholder. This serves as a level of protection where their independence might be compromised.
Unfortunately, legislation and regulation is often reactive, not proactive. There are always people who find ways to work within the letter of the law, while ignoring the spirit of the legislation. Problems develop, investors are impacted, lawsuits are filed and new regulations must be written to readdress the problem.
Bryce Sanders is president of Perceptive Business Solutions
The main rights of minority shareholders
• The right to inspect corporate records – Minority shareholders have bought a stake in the business, so they should be able to check that it is being run properly. They have the right to see the list of shareholders and make copies, which is important if they want to contact them directly.
• The right to make claims concerning breach of fiduciary duty – Minority shareholders may take a company to court to question strategic decisions that went wrong. Making a ‘derivative claim’ requires approaching the board in writing, stating the reason for the claim. The board then chooses to accept or reject the demand. Reasonable doubt that the board is acting in the shareholders best interest is a plus. Meanwhile, courts understand negative outcomes can often be the unintended consequence of valid business judgment.
• Fiduciary duty of protection – The firm has a responsibility to protect minority shareholders from being oppressed by majority shareholders. This becomes an issue when smaller shareholders are at risk of losing the value of their investment, because they are bought out at a price below fair value.
• The right to maintain proportional ownership – The firm cannot dilute the ownership of minority shareholders by issuing additional shares without giving them the right to purchase enough new shares to retain the same proportion of ownership.
• The right to bring in a resolution to a shareholder vote – Subject to rules regarding minimum shareholding requirements and format guidelines, shareholders may submit a resolution to a vote of shareholders. These are familiar to shareholders who vote their shares by mail or online. The votes are addressed at the annual meeting. Often the company recommends whether shareholders should accept or reject the proposal.
Key Points
Traditionally, minority shareholders invest in a company in the hope it will be well run and increase the value of their shares, then look to exit at a point where they believe maximum value has been achieved
Minority shareholders can also be founders who have sold the business, foreign investors or shareholders retaining shares in a firm after the majority of shares have been acquired in a takeover.
Although businesses are controlled by majority shareholders, minority shareholders do have certain rights and can exert some influence.
Unrest can occur among minority shareholders when majority shareholder actions affect the value of their shares
