If you hold the majority of shares in a closely-held corporation or limited liability company, you can control most aspects of the business’s operations. But minority shareholders can still act disruptively, and sometimes you want to find a way to remove them. This guide will help explain how in general such removals proceed.
Buying Out a Minority Shareholder
Removing a minority shareholder will be simplest if you have a well-drafted shareholder’s agreement. Such an agreement will usually stipulate that the majority shareholder can buy out the minority at a predetermined price, or at a price determined by a mechanism specified in the agreement. But if you don’t have an agreement, or if your agreement doesn’t include such a buy-out clause, we’ll need to consider other options.
Lacking a prior written agreement, we’ll first attempt to negotiate a purchase of the minority shareholder’s stake. Sales of minority shares in closely-held corporations will generally be at a discount, but it’s still necessary to make a reasonable offer, or else the minority shareholder will simply refuse it.
If we can’t come to an agreement, there’s no simple way to compel the minority shareholder to sell. In general, the majority shareholder will need to address the minority’s reasons for refusing to sell, convincing the minority to accept a fair value for their shares.
If the minority shareholder were only interested in their shares’ monetary value, after all, it would generally be possible to agree on what that value was, and to buy their shares for that amount. If they refuse to sell given a fair offer, it will often be because they value something else about being a partial owner. If you remove the minority shareholder’s nonmonetary reasons for retaining their shares, they may become more willing to part with them.
Encouraging a Minority Shareholder to Sell
When attempting to remove a minority shareholder’s incentives for retaining their shares, you need to be careful not to engage in what is known as minority shareholder oppression. For more on minority shareholder oppression, see [LINK]. If you do engage in oppression of a minority shareholder, that shareholder can pursue equitable remedies.
Generally speaking, only certain actions will quality as minority shareholder oppression. You should avoid:
- Withholding information shareholders would ordinarily receive.
- Withholding profits, by refusing, for example, to issue dividends.
- Otherwise violating the minority shareholder’s rights as owner.
- Acting against the shareholder agreement.
The general rule is that the corporation must be operated for the financial benefit of all shareholders, not for that of the majority only.
This leaves open many actions that could succeed in encouraging the minority shareholder to accept your proposed buy-out. You could:
- Terminate their employment, so long as the employment agreement and applicable employment law does not prevent it.
- Cease doing business with them, if, in addition to holding shares in the company, they are a vendor or consultant.
- In general, operate the company as you see fit; given that you hold a majority of the shares, you can block the minority shareholder from having a say in most of the company’s decisions. Be sure, however, that you always act in accordance with the procedures for corporate decision-making laid out in the shareholder agreement.
When a minority shareholder discovers that their shares do not entitle them to as much decision-making power as they supposed, they may become willing to sell.
The Last Resort: A Freeze-Out Merger
Sometimes, however, the minority shareholder will refuse to sell for a reasonable value, despite your best efforts. Under Texas law, your recourse at this point will be to initiate what is called a freeze-out merger, effectively starting an entirely new corporation, limited partnership, or limited liability company, without the participation of the undesired minority shareholder, and then forcing the minority shareholder to accept the merger of the existing company into the new one.
In a limited liability company, the process for initiating such mergers will be governed by the partnership agreement. Lacking such an agreement, a majority of owners (who need not own a majority interest in the company) can initiate a merger. In a closely-held corporation, minority shareholders can dissent from the merger, which can significantly complicate its resolution, but they cannot ultimately prevent it from taking place.
When a freeze-out merger takes place all current shareholders receive consideration for their shares in the old company. The majority shareholders initiating the merger receive equity ownership in the new entity, while the departing minority shareholders receive the cash value of their shares.
The value the minority shareholders receive should be that at which the shares would be valued in a judicial appraisal. When a shareholder dissents from a merger, they will generally be dissenting from the proposed valuation, and their remedy will be for the value to be determined by an independent appraisal.
Court-ordered appraisals mean additional time and expense. They also bring the operations of the company under additional scrutiny. For these reasons it’s generally best to make a fair valuation to begin with. This valuation should usually take place before the new entity for the merger is incorporated, so that it can be used as the basis for a buy-out offer.