According to the World Bank, there are more
than 160 million privately-owned small and medium-
sized enterprises in the world employing more
than 500 million people.

Many of these businesses are family-owned, with
tightly held shareholdings. They are very often
well-established companies where control has
been maintained by a small of group of individuals
since inception.

In an increasingly demanding economic environment
there are a myriad of new challenges facing
family-owned business models, ranging from the
threat of advancing technology to succession planning
for younger generations with different aspirations
than their parents.

Opening up share capital to third parties is often
a difficult, but necessary step to free up capital
for investment, or to offer incentives to existing
employees. It may also be done in order to attract
talented individuals as part of a succession plan,
or to lock in reliable suppliers or customers.
Releasing value for owners, or generational estate
and tax planning are other reasons.

According to a 2019 survey of US family businesses,
conducted by an international consultancy
firm; 47 per cent of firms surveyed are planning
to bring in outside expertise to help them run
their company, while 39 per cent expect to merge
with another company within the next two years.
More than a third of firm’s said they were open to
bringing in private equity (PE) to help fund their
business and the report noted that PE houses are
renewing their focus on the family-business sector,
carving out specialist teams to do this.

Whatever the reasons for restructuring the share
capital, there are different challenges and dangers
that need to be assessed thoroughly before any
action is taken.

Chief among these is loss of control. Negotiating
with a private equity funder is very different
to dealing with another family member, and will
require much more attention to detail in order to
ensure that too much is not given away in exchange
for an injection of cash.

On their part, potential investors will attempt to
maximise control in exchange for their investment.
A highly-negotiated transaction might include
mandatory dividend distribution rights, or the
essential veto rights on decision-making. It could
also have clawbacks or provisions that would
entitle them to increase their ownership in the event
that certain performance criteria or thresholds are
not satisfied.

Examples of ways to mitigate loss of control,
include the use of a shareholders’ agreements,
or the sale of different classes of shares without
voting rights. Clauses that guard against some of
the issues above would be recommended. With
regard to restructuring for succession planning,
vehicles such as trusts can be used to transfer
value while mitigating tax.

While it is clear that many privately and family-
held enterprises must open their share capital
in order to achieve their goals, many owners don’t
fully understand the risks inherent in doing this.
Without proper advice and guidance, it could lead
to major strategic decisions being vetoed by new
shareholders, or worse, a total loss of control of
the business.

The following feature draws upon the expertise
of ten professionals with significant experience of
helping privately-owned enterprises to restructure
their share capital. These experts share the benefit
of their wisdom around the reasons for restructuring,
the risk involved and why using an advisor
is crucial.

What are some of the common reasons that private enterprises might take on minority shareholders?

Bruno Pichard – France (BP) A familyowned
company in France may want to open
its share capital for various reasons.

First, the owners may want to realise value,
though they are not able to withdraw cash
from the company. This is either because the
company doesn’t have the cash, or because,
for tax or legal reasons, it is more convenient
to sell or open the share capital to someone
else.

The company may also need to develop
its activities and find cash to finance new
development. This financing may be done
by bank loans, but it can also be done by
increasing share capital, which for the
company may be more comfortable. When
share capital is used, the company doesn’t
have to repay a loan. The shareholders may
have to buy back the new shares, but not the
company itself. The most popular route to
raising capital really depends on the minds
of the shareholders. Some family-owned
companies really do not want to open the
share capital and so they will always prefer
bank loans. Other firms are more reluctant
to use loans and they prefer to increase the
share capital.

Sometimes there is a minority release,
meaning that some members of the family
want to sell their shares or get money from
the company. In such a case, the other
members of the company may not have the
available cash and so they need a third party
to finance this withdrawal.

Another possibility includes the joint venture.
This may be used when a company has
to make an alliance with a competitor or
somebody else in the same market. In such
a case, it may be useful to have a common
company through a joint subsidiary. This can
also be achieved through the opening of the
share capital of the family company.

A final reason to open share capital, is as
an executive incentive. In France, in a familyowned
company, executives may feel that,
as they are not members of the family, they
do not have the same opportunities they
may have in another company. For instance,
private equity funds which own French
companies, may open the share capital of
the company in which they invest. This gives
executives or senior executives, a significant
opportunity to make capital gains which
attract less tax than salaries.

Alex Canham – England (AC) In the case
of family run enterprises, it can be tempting
to keep the shareholding within the family
and with people who are trusted. However,
minority shareholders can add value to a
company.

Minority shareholdings have to be offered for
the right reasons. In England and Wales some
of the more common reasons for offering a
minority shareholdings are to bring an expert
into the company, to grow the company by
way of investment, or as part of an employee
share scheme.

Rather than simply offering an employment
role, an expert may be incentivised by being
offered a minority shareholding. Not only
does the company get the benefit of their
expertise, but the expert has the opportunity
of benefiting by way of increased value in
their shares by helping to grow the company.
Employee share schemes are often used
as a way to incentivise key employees, by
offering them the option to purchase a small
shareholding in the company. This option is
normally not able to be exercised until the
employee has been with the business for a
certain period of time. The option is often
granted for an agreed price, and this means
that if the value of the business grows then
the employee is able to effectively buy the
shares at a discount. If the share scheme
is drafted in the correct way it can also
provide the employees with a tax advantage
in the event that the option is exercised. It
is therefore crucial to take specialist legal
advice if considering implementing an
employee share scheme.

Minority shareholdings for investment are
commonly offered to individuals who are
looking to invest money in private businesses,
and simply make a return on their investment.
The laws of England and Wales prevent
private companies offering their shares
for sale to the general public. Therefore,
this option is typically used if the company
knows of individuals who may be interested
in supporting the growth of the company by
way of investment.

Steven Goldberg – California, U.S (SG) In
our practice, taking on minority shareholders
is often focused around the transfer of wealth
from an older generation to a younger
generation.

This occurs both from an operational (soft)
side and a legal and tax perspective in the
USA. There is a still a significant estate tax
for large estates, so developing minority
shareholders can dramatically reduce that
tax.

John Friedemann – California, U.S (JF)
As an interesting perspective, my practice
more often deals with companies that take
on minor shoulders because they’re looking
for capital.

That’s the core difference between Steve’s
practice and mine, because he’s dealing
with high net worth clients that are looking at
estate planning and generational transfer. I’m
looking more at traditional businesses that
don’t have those circumstances.

U.S – California – SG In family businesses we
are often structuring executive compensation.
We see that a lot up here in California with
wineries, where a certain prize winemaker
may get a percentage of the winery. It is also
done to keep key employees in place.

Minority shareholders have some informational
rights, but they don’t have a lot of
control. This lack of control translates to a
lack of liquidity and marketability and actually
drives down the value of minority interests.
In other words, it is often the case
that all of the parts are not worth the same
of the whole.

U.S – California – JF If you’re evaluating an
ownership interest, then a person with more
than 50 per cent ownership is going to get
full value measure of appraisal for that value.
Somebody with a minority interest will have a
minority discount, which might be up to 30
per cent.

US – California – SG With transfer taxes in the
United States, valuation is very important. A
niche group of appraisers are often used to
value minority interests and discounts can range
from 30 per cent to 60 per cent depending on a
variety of factors, including cash flow, leverage,
and the size of the business.

Germany – MS There are four areas where I
can see constellations in Germany that lead to
shareholders taking on minority shareholders.
In Germany, we have very traditional companies
which are driven by certain families over
generations. They have a generational problem
because younger generations are not willing
to drive the business forward. In this case,
someone takes over as managing director
and this person quite often gets a stake in the
company.

The second area is a management buyout
(MBO), which happens quite often in the automotive
sector. Key employees who have influence
in the company may enter into it as a
minority shareholder.

Thirdly, we quite often see a merger of two
companies, usually a small company and a
larger company. The shareholders of both
companies found a holding company and
become shareholders in this holding company.
The holding company then owns the two former
companies.

Minority shareholders can also be created when
venture capital is required.

One main issue in transactions is with respect to
companies who have real estate. This is in order
to avoid the tax on the transfer of real estate
when you sell the shares in a company. The
solution is that the old shareholder maintains 6
per cent, so there’s no tax on the transfer of
shares regarding the real estate, which is in the
target company.

Do you have the same in the US?

U.S – California – SG The US does not have a
similar rule. If you have a sale of shares in a
US company, there would generally be tax on
that sale if there is a gain. There are strategies
that we use to minimise or defer tax. The tax is
levied, typically, on the difference between the
seller’s cost (adjusted for a variety of factors)
and the proceeds from a sale.

Don Looper – Texas, U.S – (DL) We have three
very different practices here, which gives a very
different look at this issue.

I would say 95 per cent of all our minority
investing work is representing private equity
funds. Money is a key factor in why the transaction
is happening, but the primary benefit is
typically to gain a strategic partner.

The drafting of those agreements is materially
different. Steve is focused on the minority
interest holder breaking up the family interest so
that the values are lower for estate tax purposes.
Our focus when drafting those agreements is
almost always focused on maximising the value
of that minority interest. That comes in the form
of mandatory distributions and the mandatory
decision making authority of the minority
interest.

It is materially different when you’re drafting the
agreements and you’re representing the minority
interest. Your goal is to make that minority
interest very valuable and possibly even a
secured transaction.

Another reason we might do this is to create
strategic partners. We have one client in Arizona
that has an international agriculture pesticide
company, they have sold a minority interest in
some of their subsidiaries, purely for strategic
purposes. Once that party becomes a minority
shareholder, they have an incentive to always
buy their product from the majority owner. The
owner then locks in a natural sales stream.

The minority investor is coming in with capital
and they are dictating the terms, which makes
that minority interest very valuable. They might
have mandatory distribution rights, or the essential
veto rights on decision-making. They could
also have clawbacks or provisions that would
entitle them to increase their ownership in the
event that certain performance criteria or thresholds
are not satisfied. That’s a very different type
of drafting and they’re usually highly negotiated
transactions.

U.S – California – JF You touch upon an interesting
dichotomy in these transactions. If the
transaction is generated by the owner wishing to
pass to another generation, then it’s an ownerdriven
transaction. If they need venture capital,
then it’s an investor-driven transaction and now
it’s an entirely different set of documents and
entirely different terms because the investors
have all the power in that situation.

U. S – California – SG There’s obviously very
different motivations. If I’m counselling a family
on a transfer of wealth, the motivation for the
transfer is usually very different than unrelated
business partners, who are looking to maximise
profit. Within families, gifts are common.
However, unrelated business partners usually
have similar motivations as Don’s clients; they
will try and get the best deal that they can.

Lavinia Junquiera – Brazil (LJ) Businesses may
need to offer equity to third parties to obtain
further capital, skills or expertise. Thereby
founders can also sell shares, have liquidity.

This process of selling shares needs to protect
the company and its shareholders from loss of
control, hostile takeovers, and disputes between
shareholders in the controlling block. Professional
advisers can obtain insights from multiple
stakeholders to identify their individual goals,
needs and possible compromises. They apply
legal tools that help find solutions to restructure the company while reaching multiple goals to bring harmony and stability for the
company´s continuing success.

Robert Lewandowski – Poland – RL There
are currently around 823,000 family-owned
enterprises operating in Poland. They make
up between 60 per cent and 90 per cent
of all SME businesses in Poland. The two
most common forms are limited partnership
and private liability companies.

These private enterprises might consider
taking on minority partners/shareholders
to finance growth projects, increase the
value of their enterprises or to acquire other
enterprises on the market.

Comprehensive analysis carried out
in Poland shows that most enterprises
still prefer to take loans from banks to
finance future endeavours (over 77 per
cent). The issuing of shares on the stock
market, or venture capital investment, is
not widespread, however this alternative is
becoming more popular in Poland.

Family-owned enterprises are not used to
going public (being enlisted on the stock
exchange market), therefore private equity
is still the most common means of equity
funding in Poland. This may take many
forms, such as venture capital (gaining
capital at an early stage of a family-owned
enterprise) or mezzanine capital (mixture of
own and foreign capital).

John Colter – Mexico – JC Family owners
often pursue a share reorganisation to
achieve their goals. This could be parents
who own a family business and wish to
bring their children into ownership but
retain voting control. In such a situation,
the parents can convert common stock
to preferred voting stock and then issue a
preferential stock dividend on the remaining
common stock – which is non-voting – to
the children. Such stocks will not be entitled
to vote in certain matters, such as
increasing or reducing capital stock participation,
merging the company or certain
transfer of ownership, among others.

Another reason is when the private
company needs investors to achieve a
special project and wants to transfer certain
stock participation ownership in exchange
for a determinate joint venture project.
It is common to set up drag-along and
tag-along terms and conditions on the joint
venture. This means that, after the project
is complete, they may have the opportunity
to return their capital participation on the
company.

Private companies normally raise finance
though financial institutions, such as banks,
and they normally grant certain kinds of
mortgage and pledge guarantees to secure
the loans. They may grant a pledge over
their own stock certificates to secure the
debt been granted, but is not common to
bring on third parties that will finance the
company in exchange of a stock participation.

Thomas Paoletti – UAE – TP From a UAE
perspective, we have to take into consideration
that we may have family companies
which are reputable in the market and are
not keen on accepting investors or minority
shareholders. They tend to protect themselves,
because there are some activities
which may only be run by Emirati families.
Other companies may seek investors, and
typically this happens during the start-up
process. During the process of setting up
they find investors who are willing to invest
and put some equity into the company. It’s
quite difficult for a start-up to have access
to bank loans so they might consider
equity.

Financial loans facilities are only available
if you have at least three years of activities
and you have a verifiable audited balance
sheet of the company. Otherwise, it is quite
difficult to have access to bank loans or
banking facilities.

In some situations, these investors want
to control the terms of governance of the
company.

They want to make sure that the investment
is properly addressed to the requirements
of the company and they also take a stake
in the company.

The well-known Emirati families typically
have an exclusive agency agreement and
act on behalf of big corporation like Microsoft,
IBM or CarreFour. Any transaction
these companies wants to do in the region
has to go through these families. They will
also typically put their own people in the
management because they want to have
some sort of control around how the business
operates.

Only an Emirati family can have this kind
of business. Foreign investors cannot run
them.

Tuomo Kauttu – Finland – TK Minority
owners realising value, is not one of the
most common reasons to open the share
capital of a company in my experience.
Realising the value of whole stock is much
more common.

It’s difficult to find buyers who are prepared
to pay the real price of the real value of
a minority share of the company. Family
companies are operated differently than
public companies or private companies
that are not family owned.

Generally, buyers don’t think that owning
minority shares has a real value. If the firm
is operated by the majority shareholders, it
means you really don’t need such shares.
In most cases buyers gain higher profit by
investing in other kinds of companies.
There are many cases just around shareholder
agreements. It is not common for
owners to realise the value of their shares
by selling shares to outsiders, if that is a
minority share of the company.

It is a totally different situation when we
are discussing financing the growth or
expansion of the company. It’s much more
common to distribute shares to outsiders
to get capital or equity in the company.
In many cases, those outsiders who
are intending to contribute equity to the
company attribute a different value to such
shares than the owner.

There are many tools, investors can use to
protect their ownership in the case that the
shares are distributed by the company in
exchange for equity, in comparison to the
situation in which the shareholder is realising
his or her minority shares’ value.

Generally, owners can protect their ownership
and power by shareholder agreement,
class of stock, and redemption and
consent clauses in by-laws/articles of the
company in addition to similar conditions
in shareholder agreement. Naturally, an
investor has much more influence to all
of such tools when the shares are distributed
by the company due to need of capital
rather than sold directly by minority shareholder.
Similarly, the existing shareholders
can improve their rights against new shareholders,
depending on the negotiation
power on both sides.

There are also some other relevant reasons
for opening share capital, including tax
planning. In some case in this is why the
family owners are obtaining minority shareholders.
Generational shift or transition to
immediate family or a third-party due to
retirement is also a reason, as is expansion
into foreign countries.

What are some of the risks inherent in making changes
to the structure of share capital? How can clients legally
ensure they retain control within the family?
Any examples?

Brazil – LJ The legal puzzle around maintaining
control may include the following
considerations.

Should the company have only one class
of shares or multiple classes, with different
economic and/or voting rights, and should
the controlling block be organised in one
or more holdings through a shareholders’
agreement.

They must also consider the major
economic and political powers that the
shareholder(s) cannot compromise, plus
the risks that they will not take, and the level
of protection inherent in this structure.
Rules around conflict of interests, transactions
with related parties and corporate
governance in shareholders´ agreements
or memorandum and articles should also
be included.

In the latter situation there should be a
thought about whether the management
functions can be reinforced. The involvement
of the shareholders in the management
or board of directors should also be
considered. The application of remedies
and conflict resolution methods concerning
these shareholders and the company, is
important.

Poland – RL Most family members insist
on keeping control over the enterprise after
taking on a minor shareholder or a minor
partner. They are interested in limiting
the rights and powers of a new investor,
however, there is always some risk of losing
control, for instance in the case of the enterprise
being indebted or via a hostile takeover
through redemption of shares.
Control will be ensured through signing
family favourable investment agreements
(partner agreements or shareholder agreements
in addition to their formation agreements)
between family members. The new
investor will be kept away from key issues
involving the running and development of
the enterprise.

This can be done by limiting casting votes
attributed to shares/interests offered to
a new investor and not allowing a new
investor to be involved in decision making
process.

In such circumstances the new investor
is limited to a passive position. They are
vested with rather poor rights and powers.
This may be wish of family members,
however, new investors usually try to gain
more influence over business, leading to
tensions and disputes within the negotiating
process.

Mexico – JC While the steps required for a
share reorganisation may seem simple, a
great deal of effort is required to manage
communications regarding governance
changes. For family businesses, in
particular, shareholder communication is
critical to ensure that there is buy-in and
everybody ends up where they intended. It
is important that shareholders understand
the impact in terms of board seats, voting
rights, preference, subordination and dividends
vs. interest payments.

For many family businesses, there is also
an emotional aspect if the reorganisation
results in ownership differences between
various family members.

Those who pursue a share reorganisation
must understand that if a company gives
away stock, and the only difference in the
stock is voting rights, all shareholders have
the equal right to participate in the firm’s
profits. Thus, owners must decide whether
they are ready to give up a percentage of
ownership in the company, even if through
non-voting rights. In short, in most shareholder
reorganisations, all shareholders
have shared economic interests whether
they hold voting or non-voting rights.

In family-owned companies, it is now more
common for the family to be very involved
in the board and committee meetings and
to structure the family protocol to minimise
the risk of a loss of control or a hostile takeover.
They may also set up internal family
rules to negotiate any dispute between
them.

England – AC Company law in England
and Wales provides protections for minority
shareholders who start to acquire rights
once they own a least 5 per cent of the
company’s shareholding.

However, in order to make meaningful
changes to the structure of the company,
you need to own at least 50 per cent of
the shares. To force through some fundamental
changes to the company’s constitution,
you need to hold or control at least
75 per cent of the shares. The easiest way
to ensure that the family retains control, is
to make sure not to offer more than 24 per
cent to minority shareholders. The family
should also strongly consider putting in
place a shareholders’ agreement governing
rights that attach to the shareholdings. They
should also consider whether they offer the
minority shareholders a different class of
share with different rights attached to them.

Hostile takeovers tend to be less of an
issue for small private companies, as the
minority shareholder would need to get
enough of the other shareholders on side
in order to force through changes to the
structure of the company.

Disputes between family members,
however, can be more common, and can
cause major issues in running the business
effectively. Most decisions of the company
are made by the directors, and so if key
family members also act as directors and
fall out, this can prevent day-to-day decisions
being made. In family companies,
the shareholders and directors are often
the same, and so if there is a dispute it
is normally difficult to get agreement to
remove a director.

There is no specific provision within
company law in England to deal with a
difference of opinion in relation to the
strategy of a company. The running of the
company is undertaken by the directors, and if the shareholders have a difference of opinion regarding strategy their most powerful remedy is to seek to remove
the director. If the dispute is between
directors, then they will need to reach a
commercial conclusion.

UAE – TP In the UAE we have different
kinds of companies. We have a company
set up in the Free Zone and a company
which is set up on the mainland. The
difference is that Free Zone companies
can be 100 per cent owned by foreigners,
while mainland companies must be 51
per cent owned by a local Emirati entity
or individual.

In the case of a mainland company the
best thing in order to mitigate the risk
is to have a shareholder agreement in
place. Typically, the shareholder agreement
takes care of the key governance
issues and makes sure that the shares
are pledged in favour of the investors and
the local partner should release power
of attorney. You should make sure that
during the process of the incorporation
of the company, the profits are distributed
between the partners in a different proportion.
For example, in Dubai the minimum
that can be allocated to the local Emirati
partner is 20 per cent of the profit.

A similar solution is suitable for the free
zone companies. Since the free zone
authorities are more or less like an
administrative authority (i.e. they don’t
take any decisions with a direct impact
on the company structure or business),
any dispute between partners is to be
prevented or solved in the articles of incorporation
or with appropriate shareholder
agreements.

Court proceedings should always be
avoided and in our experience we see
that shareholders’ agreements are the
proper tool to prevent and mitigate any
risks during the life of the company. If you
don’t have unanimous consent, you will
be forced to go to court and get an order
from the court.

We had a case, where a client was holding
95 per cent of the shares in a company
in a Free Zone of UAE. The other 5 per
cent was in the name of an Indian individual
who was also the manager of the
company. The majority owner was not
able to change the manager because
unanimous consent was required.

Usually the shareholder agreement has
to take into account different aspects of
the business. What we need specifically is
that the local partner is holding the shares
on behalf and in trust for the investor.
This should ensure correct profit distribution
and make sure that there’s a proper
governance structure in place.

These are the elements that we will usually
take into account when we have to deal
with this kind of situation.

Finland – TK I would say that in all cases
shareholders’ agreements are relevant.
Beyond this, according to Finnish law it
is possible that the bylaws/articles of the
company contain conditions, especially
redemption and consent clauses, that can
help to manage these things. Also, class
of stock may affect to proceeding when
making changes to capital structure.

France – BP If a family-owned company
opens its share capital, the new shareholders
will ask for some rights. This
might include asking to participate on the
board of directors, or access to specific
information on the management of the
company, or its turnover.

There are some risks for the company in
these requests. The first one is that there
will be new directors within the company
as well as new shareholders. It means that
the management of the company may
become more complicated, so it has to be
a serious consideration.

The second point is that if there are people
who are investing in the family-owned
company, there is a risk of indiscretion as
regards the information disclosed by the
company to the new shareholders or to
the new directors.

The members of the family will lose a part
of the control of their company and they
have to accept this. People are not going
to invest in the company without getting
some rights and control of its management.
This is true even if they do not want
to be involved directly in the management
of the company.

Sometimes in France, it happens that new
investors take advantage of some dispute
which may exist between family members.
They might side with one group of family
members against the other group, just
to get a majority control of the French
company together with the first group. At
the end of the day, they are able to take
over the whole company because all the
members of the family prefer to sell their
shares to these new investors, rather than
to keep on fighting each other.

If the dispute doesn’t go as far as the sale
of the company, there can be a dispute
regarding the strategy of the company.
This may happen between the members
of the family and the new investors who
may have different point of views. It is
necessary to take into consideration this
possible dispute and how it would be
solved.

It can be possible to mitigate the risk by
using different types of shares. Investors
can then invest in the share capital of the
company, but their voting rights can be
reduced, so they will not be proportional
to their shareholding. This may also be
done through a shareholders’ agreement,
where the members of the family may
have some priority rights.

We also need to consider the needs of
the members of the family, not only from
a business perspective, but also their
private needs. If, for instance, we realise
that one minority shareholder member
of the family needs cash to buy a flat, or
to help his children, this shareholder will
look to find a solution. This might include
selling shares to a new investor.

U.S – California – JF We have seen clients
who have started up new businesses and
had some success. When they are ready
for the next stage, they will come to us and
ask about taking on investors.

At that point we have a very serious talk
with them about what the implications of
that are. They’ve been running that business
as their own private business, but
now they’re going to have minority owners.
There’s a huge risk to them if they don’t
understand the implications of bringing on
investors. The investors will want things
from them, such as information, control
and accountability.

In the transactions in which we are
involved, there is very significant risk of
serious regulatory liability when investors
are taken on. If they don’t follow all of the
requirements for disclosure under securities
law, for example, the original owners
could face serious liabilities.

U.S – California – SG If you discussing
a family group, versus unrelated parties,
the analysis is different, but even within a
family group, the older generation often
wants to retain control. A fairly common
strategy for us is to use voting and
non-voting interests. This is fairly easy to
do and very often the tax consequences
are relatively benign.

U.S – Texas – DL In a capital transaction,
you’ve usually got a minority shareholder
with leverage. You would be specifically
negotiating voting rights and voting control
over certain issues.

I would list that in three different ways.
Voting control over certain issues,
securing the investment by terms of the
contract and then mandatory distribution,
so that the majority can’t prevent the distribution
of profits.

When Marcus raised the issue of
employees being given interest, it would
be exactly the opposite here. The majority
are trying to make sure that those
employees do not have the right to control
decisions.

Germany – MS It’s also important to define
what a minority shareholder is. I would say
it’s a shareholder with less than 25 per
cent of the voting rights. In Germany, this
individual would not have a veto right, and
they could not oppose a shareholders’
resolution. The majority, holding 75 per
cent or more, has the control regarding
resolutions in the shareholders’ meetings.

We do, however, quite often have a
problem with minority shareholders
regarding controlling rights and we see
minority shareholders making things hard
for the managing director and majority
shareholder. They can ask thousands of
questions regarding the management
decisions, or why resolutions were made
in a certain way. We also have a lot of
problems with the invitation to a shareholders’
meeting. A minority shareholder
can say that he has not received the letter
of invitation and that there is a material
mistake. You cannot avoid these risks.

U.S – Texas – DL In Germany you can
contract that right though I believe. A new
investor can contract the right to veto a
decision?

Germany – MS Yes, that’s possible.
U.S – California – JF In the US, there are
ways for sellers to deal with it limiting interference
from the investors, if you have the
leverage.

One way is to sell a different class of
shares limiting the minority owner’s ability
to interfere with the ongoing operation.
That’s one mechanism that can be used if
the original owner of the company has all
the power and leverage.

If they don’t have that kind of leverage,
then it’s absolutely true that the investor is
going to dictate terms that will give them
the power to create trouble, because they
want to protect their minority investment.

How can professional advisors smooth the process and
ensure the redistribution happens efficiently and achieves
its goals? Any Examples

U.S – Texas – DL In the US, it has become
normal to work using limited liability
company agreements for private transactions
and not public companies. But even in
private transactions among public companies,
the use of limited liability company
agreements and complex partnership agreements
is happening.

In the case of structuring wealth for families
or bringing in employees, it’s much more
common to use shareholder agreements, or
often no agreements at all.

I would say that most of our transactions
use limited liability company agreements
that are highly negotiated with details on the
rights that are given to the minority investor.
This includes control rights, security rights,
methods of securing the investment and
possibly even ways to increase their share
if the company doesn’t perform to the levels
negotiated.

U.S – California – JF Do you see situations
where minority interests are protected by the
preferred status of their ownership interest,
where any dividends or any distributions get
paid to them first according to certain ratios?

U.S – Texas – DL With private equity investments,
there’s always a waterfall distribution
method of drafting the partnership agreement.
As a tax lawyer the most material difference
between a private equity limited liability
company agreement and a non-private
equity limited liability company agreement is
the method of distributions and allocations
of profits.

Private equity funds tend to draft all of their
limited liability company allocation provisions
on what is called the target method of distributions.
The agreement drafts specifically
how the cash is distributed, ensuring that
the private equity fund has a certain return
coming back to their investors. It’s based on
cash and then the profits and losses are left
to the accountants to figure out allocation.
The private equity funds don’t care, since all
they’re looking for is cash.

In a normal transaction between two businesses,
the profits and losses section would
be focused on what your share of profits
would be, or what your share of losses would
be and then distributions would always follow
based on the capital account accounting.

U.S – California – SG I cannot resist the
temptation to add that, whether it’s a family
situation or non-payment situation, cash
flow is always important. Clients are always
concerned about that.

In the family situations, we actually end up
using LLCs quite a lot to establish different
kinds of partnerships. This is especially true
for assets like real property.

The entity structure and how we’re going
to govern businesses and assets from one
generation to another is a big part of what
we do as professional advisors. A big part of
my practice in those transfers are multi-generational
trusts, which probably would not be
used outside of families.

I think the equivalent in Germany is a foundation.
If you say foundation in the US, you’re
thinking of something that has a charitable
requirement, but I think in Germany the foundation
is a private family arrangement similar
to a trust. We use all kinds of trusts to accomplish
our goals as professional advisors.

We translate these structures in an intelligible
way for our clients. It’s very common for us to
use diagrams and charts to show the clients
what the legal documents are going to do.
Our family clients love seeing the diagrams
showing how things are going to flow. It aids
their understanding tremendously.

Germany – MS Some very rich families in
Germany have a family foundation and this
will hold 100 per cent of the operating business
of the companies.

We work with a large company, where all
the profits from operations go into a foundation.
The foundation then aims to invest
all the money back into the company. This
secures the future of the company because
the profits will not go out of the family.

The family members themselves only have
salary agreements and they get a salary
from the foundation for their services. You
do not have minority shareholder problems,
because in this foundation everyone is a
member, rather than a shareholder with profit
interests.

U.S – Texas – DL This is actually very interesting
and something we would never see in
my practice.

We’re currently representing an international
religious organisation doing some restructuring,
which has caused me to look at
something else that I had really never looked
at before. That is the use of limited liability
companies for non-profit 501 C 3 organisations.
Delaware and two other states have specifically
authorised the use of limited liability
company agreements for non-profits, and
then another series of 20 or so states have
permitted it.

The reason I raised that is significant,
because the limited liability company is
used so much due to its ease of preventing
piercing the corporate veil.

State laws are very good at saying that the
limited liability company does not have to
follow all of the procedures for giving notices
to shareholders and doing all the things
you have to do in the corporate context.
As a result, the limited liability company is
an easy form to operate with and still maintain
a limited liability for the members. In a
non-profit organisation structure, the parent
company with a large valuable church
building as an asset, can operate its for-profit
activities in a separate limited liability
company agreement. If an accident occurs
that would give rise to liability, this insulates
the non-profit parent from that activity.

U.S – California – JF I’m working on one right
now, where we have European owners and
Californian owners of a business. They own
the business equally and there’s a conflict
over the direction of the company.

We’re working on a resolution to resolve the
future of the company. My client is the Californian
entity and only the California entity.
We have to always be very careful about
who we represent and we can’t act in the
middle between different parties unless we
are formally designated as a mediator. It’s certainly the kind of thing that we get involved in on non-family business transactions as well, where we resolve disputes among owners by advising the parties.

It’s certainly the kind of thing that we get involved in on non-family business transactions as well, where we resolve disputes among owners by advising the parties.

One thing I want to add, is something interesting in California. It’s
called judicial reference for the solution of disputes.
There are problems with arbitration and there are problems with
going to traditional courts to litigate. Judicial reference is a cross
between the two, using a retired judge who works privately to resolve
a dispute, almost like an arbitrator, but in accordance with all of the
applicable laws of California.

The parties hire the judge and direct the judge in terms of the
process, so it can be done privately and quickly. It follows the law,
unlike arbitration which does not necessarily follow the law, and is
subject to appeal. You get a ruling that you can take up on appeal
if need be and it creates a very interesting statutory alternative in
California.

U.S – Texas – DL We have judges and former judges that permeate
our arbitration list, but the only way in Texas to have it subject to
appeal, is if the arbitration clause specifically provides that the decision
can be appealed if it didn’t follow the law.

US – California – JF In California, it’s all set up by statute, which we
sometimes call our ‘rent a judge’ program.
France – BP As advisors, we always discuss with our clients the
extent of the power they are willing to grant to new investors to avoid
dispute on this loss of power.

I have seen disputes happen with a family-owned company, where
one member of the family who runs the company, was not accustomed
to discuss with foreigners the strategy of the company. With
new investors, you will have to get accustomed to this, so the only
question is how it will happen and to what extent.

What decisions will require the approval of the new shareholders
is one specific point, while what kind of information will need to be
provided is another.

It is also important to determine if the new shareholders are here just
for a limited period of time or if they’re here to stay. Some new shareholders have invested with no intention of selling the shares, but the
situation is quite different when the new shareholders have decided
they will sell, for instance, within five or seven years.

It is necessary during the investment process, to not only think about
how the first investment is made, but also how the new shareholders
can resell their shares within this period of time. In France, one solution
is often an agreement between new and family shareholders,
providing that if no solution is found for the sale of the new shareholders’
shares, the family has to sell the whole company.

This means that if you do not have a solution within five or seven
years, the family company will no longer be a family company.
It is our duty as lawyers to explain to all the members of the family,
the content and the impact of the new agreement, especially if it
happens that there are only one or two key members of the family
who negotiate this agreement with new shareholders while the other
members of the family, do not participate in the negotiation.

We do not only discuss legal aspects, but also the details of the
strategy of the company and also the needs of the members of the
family. This includes what their plans are for the next few years.

For instance, if it is a private fund which invests in a French company,
then they may not want distribution of dividends. All the members of
the family would have to accept that, for four, five or six years, there
will be no distribution of dividends. This has to be explained to them,
otherwise a dispute may happen

UAE – TP Typically, a shareholder agreement is the first thing to put
in place. The key things to take into account are how to secure the
distribution of the profit, plus proper governance structure.
If these aspects are properly taken care of in the shareholder agreement,
minor disputes among partners are unlikely and in any case
far more manageable.

To this end, we typically use arbitration clauses, or the court of the
Dubai International Financial Centre, because it is a system which
is more like English law and a perfect forum especially for investors
coming from abroad.

Finland – TK Shareholder agreements are always relevant, as
are articles/bylaws of the company. In that sense, it’s possible
to have a redemption condition in articles or bylaws that can
be used in the same way as share classes, for instance voting
rights.

Brazil – LJ It is important to work with the shareholders and the
company to define a clear strategy and vision and a clear corporate
governance with functions. Putting in place independent
managers, that act apart from shareholders, is also a crucial
part of the corporate governance.

Mexico – JC Negotiating an offering of share capital, will
normally be formalised first by amending the company’s bylaws.
Depending on the kind of transaction, the parties may also
execute a joint venture agreement or a shareholders’ agreement.
For matters involving family, they will execute a shareholders’
agreement and afterwards will execute family protocol that has
been previously designated by a professional in the area.

Poland – RL The terms and conditions under which a new
investor joins a family-owned enterprise are commonly subject
to regulation of the shareholders’ agreement, in the case of a
private company, and a supplemental partnership agreement in
the case of a limited partnership. These agreements must define
the scope of rights and obligations of a new investor

Additionally, the following clauses ensure a smooth realignment
and maintenance of control over the enterprise by family
members.

The exact identification of the purpose of investment, plus ways
of providing financing by a new investor (e.g. through increase of
the share capital along with providing share premium.)

Clauses around the attribution of shares to the new investor, the
future distribution of profit/dividends between family members
and the new investor are worthwhile, as are buyout clauses of
the shares of the investor by family members after execution of
investment through a drag along clause and a clause relating to
the new composition of management board/supervisory board
favouring family members.

England – AC There are a number of ways that professional
advisors can smooth the process to ensure that a redistribution
happens efficiently and achieves its goals. These include project
managing the process, by prompting the parties to discuss difficult
subjects at the outset (for example, what happens if there is
a dispute). We can also help to implement appropriate mechanisms
or safeguards, by ensuring that the rights and obligations
of the parties are clearly documented, with the aim of reducing
the scope for disputes in the future.

The rules in accordance with which the company must be run
are set out in its Articles of Association. Shareholders will often
want to ensure that agreements between themselves and minorities
remain between the parties. It is therefore essential that the
shareholders consider putting in place a Shareholders’ Agreement.

Often when negotiating a Shareholders’ Agreement, a minority
shareholder who has invested significant sums in the business
will want to ensure that their investment is suitably protected.
This is particularly key if they will not be appointed as a director,
and therefore will not be involved in the day-to-day decision
making of the company. As previously discussed, the family will
want to ensure that it retains adequate control of the company.
One method is to set out in the Shareholders’ Agreement, a list
of matters which are fundamental and require key shareholder
consents – these are often referred to as ‘reserved matters’.

If the shares have been offered to employees as part of an
employee share scheme, then the documents governing the
scheme should be drafted by a solicitor to make sure that they
comply with the various rules and legislation. It is usual that
these employee shares will be a different class, and will not
have voting rights. The aim is to provide a form of financial
compensation, without giving them rights in relation to running
the company. The rules need to be drafted to ensure that this
is the case.

If there is a dispute between two shareholders, then it is often
recommended the parties consider mediation, however there is
no legal requirement to follow this path.