THE FINE PRINT — How do I avoid being held hostage in my own company?

August 1, 2014

By Jan Pierce

janpierceThere are a multitude of risks associated with starting your own business, but losing control of your business to your partners doesn’t have to be one of them. Luckily, unlike many business risks, you can avoid this trap with proper planning.

This article assumes that you operate as a limited liability company (LLC) or corporation. Ownership percentage is evidenced by shares of stock in a corporation, and membership interests, or units, in a limited liability company. For simplicity purposes, this article will use the term “shares” to refer to both. The principles described apply similarly to LLCs and corporations.

While officers and directors run a company, it is the shareholders (owners) who elect the directors and officers. Therefore, it is those shareholders who ultimately control the company. The percentage of shares owned by each of the respective shareholders determines how much control each has.

Controlling shareholders can hire or fire employees and raise or lower their salaries. Because most shareholders of closely-held companies are also employees, this is a big deal. Even though shareholders also get a share of the profits, those profits could be significantly impacted or reduced by how the controlling shareholders decide to spend company money. They could give themselves big fat salaries, have the company spend lots of money on things that benefit them, fire or reduce the salaries of the other shareholder-employees, and leave little or no revenues left to be distributed as profits.

If this last bit sounds nightmarish, it should. If you end up being held hostage like this, you have little or no recourse. There’s always litigation, but litigation is expensive and corporate law is on the side of the majority shareholders.

Control can be distributed via several different scenarios.

Majority Control By One Shareholder

If one shareholder owns 51% or more of the shares, he or she is the controlling shareholder. It’s a dictatorship — which can be efficient and benevolent. But they’re still dictatorships. If you are the 49% or less shareholder, you better feel 100% comfortable submitting total control to your business partner.

Majority Control By Two Or More Shareholders

The only difference here is that it takes more than one person to establish a majority. It’s slightly more democratic, but you won’t feel any less oppressed if you’re ganged up on.

Fifty-fifty Control By Shareholders

This is the most democratic, but also potentially the most destructive. All decisions require unanimous consent, but deadlock occurs if there isn’t.

Be careful who you go into business with and how much power you give them over you. Ownership interest is usually determined by how much someone is contributing to the business. But no matter what they’re contributing, it may not be worth the cost.

Send your question to jan@janpiercelaw.com. To protect your privacy, your name will not be published. Jan Pierce, S.C. is a law firm In Milwaukee that was founded with the belief that people can make a positive difference in the world and make a profit. The firm’s emphasis is on assisting small businesses and social entrepreneurs in all aspects of launching and managing their ventures. Disclaimer: Advice in this column is general legal information and does not constitute, nor is it intended to be, legal advice.

 

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