Governing Small Companies

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Term-Sheets_2How Can Investors Protect Their Investments From Majority Shareholders?

I was reading an interesting article entitled “Shell shocks market with Woodside selldown” in the Australian Financial Review on 9 November 2010. This article reminded me of questions I frequently get asked by investors considering investing in small and medium private companies. They want to know how they can ensure that the company is properly managed and also that the majority shareholder, usually the founder, does not sell out at some time in the future and leave them as minority shareholders with a new majority shareholder.

Firstly, I must say that I encourage these types of companies looking for investors to become unlisted public companies which gives investors some protection. Especially if they insist on at least one and possibly a majority of independent directors.  Unlisted public companies are required to have at least three directors and to have their books audited annually. Good corporate governance is often regarded as something just big, listed businesses need to do. That is not the case.  A functional board will exhibit a great deal of protection for shareholders and control over management.

Another thing that potential investors can insist on is a Shareholder Agreement when there is a single majority shareholder. This can cover a number of issues and usually includes rules on how the business is to be governed but, importantly and closely related to the AFR article, it usually includes what are termed “tag along” and “drag along” clauses.

These clauses ensure that, if the majority shareholder wants to sell you get to “tag along” i.e. get the same terms but also that you cannot hold out if he wants to sell as the “drag along” clause means that you have to accept the same terms if he wants to sell so that a sale of the whole company cannot frustrated by a small shareholder holding out.

The “tag along” and “drag along” clauses are important ones and I suggest you include for your protection.

Are you comfortable with majority shareholder risks, Shareholder Agreements and negotiating important protection clauses?  Do you understand unlisted public company rules and risks? Would you like our help with any of the above? Please call on +61 2 9258 1972 or go to our Contact page.

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