(Biz Law) Navigating Shareholder Complexities: Buyouts, Equity, and Business Agility
Jun 06, 2024
Michael Palermo / Matt Mittan
Ever wondered how to untangle yourself from a problematic business partner or an array of small shareholders? This episode of Biz Law with Michael Palermo offers the answers you've been searching for. We break down real-life scenarios where businesses are weighed down by countless shareholders who received equity in return for services. Discover the importance of cautious planning and well-crafted agreements to avoid these predicaments. Michael Palermo shares actionable strategies for navigating buyouts and streamlining your business operations.
Join us as we celebrate our radio shows' ranking as the number 11 business podcast in Illinois and dive into the intricate world of shareholder management. Learn why you should "hire slowly, fire quickly," and how to manage the complexities of equity distribution effectively. Through practical advice and engaging anecdotes, we unpack the high costs of litigation and present alternative solutions to maintain business agility. Tune in for essential insights every entrepreneur and business manager needs to keep their company dynamic and efficient.
Ever wondered how to untangle yourself from a problematic business partner or an array of small shareholders? This episode of Biz Law with Michael Palermo offers the answers you've been searching for. We break down real-life scenarios where businesses are weighed down by countless shareholders who received equity in return for services. Discover the importance of cautious planning and well-crafted agreements to avoid these predicaments. Michael Palermo shares actionable strategies for navigating buyouts and streamlining your business operations.
Join us as we celebrate our radio shows' ranking as the number 11 business podcast in Illinois and dive into the intricate world of shareholder management. Learn why you should "hire slowly, fire quickly," and how to manage the complexities of equity distribution effectively. Through practical advice and engaging anecdotes, we unpack the high costs of litigation and present alternative solutions to maintain business agility. Tune in for essential insights every entrepreneur and business manager needs to keep their company dynamic and efficient.
Hello and welcome to another episode of the spectacular top 15 business podcast of Biz Law with Michael Palermo. Congratulations, first off, on being number 11 in the Illinois business podcast list, so congratulations on that, thank you.
Speaker 2:
I feel like I worked hard for it.
Speaker 1:
It's all those folks that you've worked with over the years and what you did in your time in Chicago and everything. They're all just like. They're waiting with bated breath for the next episode to hit. Let's do it All right. Well, we've got some good. We've got a good topic for everybody today, and we're going to be going through and talking about some different things to take into account when looking to get rid of unwanted shareholders. Just the sentence alone gives goosebumps and shivers down the spine of a lot of entrepreneurs and managers out there. So, looking forward to talking about this a little bit. So get us started Getting rid of unwanted shareholders. What are some situations where that's going to come up?
Speaker 2:
I can't emphasize enough. There's a phrase it's hire slowly, fire quickly. And the same goes for bringing on partners to your business and partners generically, shareholders or members in the LLC. Don't just jump into business with somebody because it's like a marriage, because you've got a contract between you, operating agreement or bylaws. Hopefully they're well-drafted, which is what you call me for, but at some point you might want to get rid of some of the shareholders, either your business partner. That's one situation where you have just a full business partner 50-50, splitting thirds quarters, whatever the business size may be.
Speaker 2:
I've seen a little bit of the other situation recently, which is where you have a lot of small shareholders. So a business might give out equity to some employees, a business might give equity in exchange for services from an accountant or a vendor or something to that effect, and what happens is in that situation the business loses a little bit of its mobility because it has, you know, five or ten of these little shareholders that might hold 5% each or 3% or 12% each, and technically the business needs to take votes on certain things and it's hard to wrangle these people. It might be a couple of years since the business owners have even talked to them and when looking for financing or looking for a buyout out, uh, the financing partners and the buyout buyout purchasers are going to want to know hey, are these people along for the ride? Do we have to drag these people with us, or can we get rid of them somehow? So those are the two situations where you might have unwanted partners or shareholders in the business.
Speaker 1:
And when you're talking about getting rid of where there's a lot of smaller shareholders and everything, is that something where you offer buyouts or do you exchange something else? How does that work?
Speaker 2:
a lawsuit. Well, I went into business with this guy. He promised to do this, or this guy was going to give me accounting services in exchange for 5% or 10% of the business and he never did it. And they want to go straight to a lawsuit. And that's really expensive and especially in North Carolina. Just a basic fundamental lawsuit might take a year before you're standing in front of a judge and it's just a slog and it's not efficient. And I'm all about business efficiency. A lot of what I do really just comes down to dollars and cents. What's it going to cost to go to a lawsuit and then you might lose.
Speaker 2:
Or can you offer someone a buyout which I'm doing, that working with a small local business here in Asheville right now that one of the previous partners would just not pay some of the vendors and say, well, if you want anything, we're going to give you a thousand shares. So they wound up with I think it was about 15 of these really small shareholders and the current owner is stuck with all those small shareholders and she's trying to get financing, which is hard to do. So what she's been doing over the last probably three or four months is just offering buyouts, and it may not even be for a fair share price. The business, it's a good business, it's successful in the sense that it's well known and it's growing, but it's not profitable. So the share price is really negligible.
Speaker 2:
But if somebody gave, you know, 20 hours of CPA services or provided some computer repair, they want to get something back. So she's in a position now where she's just contacting these shareholders and offering buyouts. Hey, will you take $3,000 for your 2% ownership? We got one that's like 0.026 ownership and the holder of those shares is just being stubborn but they're really not worth anything, but it's just a nuisance to have them there. So yeah, absolutely, buyouts is a way to get rid of unwanted smaller shareholders.
Speaker 1:
Are valuations if the company is profitable, do the valuation formulas follow with a buyout similar to what they would for financing, or is it a different approach?
Speaker 2:
It's a bit of a different approach, because you ever see those pictures where somebody didn't want to sell their house when the highway was coming through, so they build the highway around the house, yeah the holdouts yeah.
Speaker 2:
Yeah, the holdout. It's the same sort of situation where if that 2% shareholder knows that as long as that shareholder is still there the business can't get financing, they might hold out for a higher buyout price over and above the actual value of the share. So if somebody were to just purchase shares for $10 a share, which to most people that would set the share price at $10 a share the holdout the guy that wants to build a highway around you they're going to say, well, I don't care about that, it's worth more to you to pay me more to get rid of me. So it's sort of a function of, yeah, what is the actual share price, but also what's it worth to the business owner just to get rid of this person.
Speaker 1:
One thing we've talked about in a previous episode and I just wanted to bring it up here, since we're talking about unwanted shareholders, or you went over some situations where that may be the case, but how do shareholder agreements fit into this? I know it's a little bit of a sidebar and there's a whole episode where we talked about that previously, but is that a totally different category thing? Or does that limit the business owner as well as protect the business owner when it comes to things like trying to remove, you know, or narrow down the people that have equity in the company?
Speaker 2:
It's absolutely not an aside here. If there's a shareholder agreement, a lot of times there could be a buyout mechanism built into the shareholder agreement. You still have the valuation problem and you still have the stubborn seller problem. But if the majority of business owners can point to the shareholder agreement the provision where the share price is set and it you know, it may be a formula, it may just say ten dollars a share, that would that a lot of times will push through that stubbornness or the unwillingness of the small shareholder to sell their shares. So shareholder agreements can absolutely come into play. You know, provide, of course, provided they're drafted properly. But it's hard to predict every situation and agreements are not. I have this saying that I tell people is that agreements keep honest people honest. But if you have someone who's going to play games, the agreement's not going to mean anything because they know that the majority of shareholders are not going to file a $15,000 lawsuit to get rid of a $3,000 shareholder.
Speaker 1:
Gotcha, I've heard the term fire sale. How does that fit into this topic?
Speaker 2:
So I generally don't do fire sales and I recommend against them because that's a good way to buy yourself a lawsuit. But what a fire sale means is that the majority shareholders of the business will create a second company and then sell all the assets of the first company to the second company that has only the shareholders that you want to be in business with. And it's called a fire sale because you know, a fire sale is everything must go, everything's at a discount. So you might have a $50,000 piece of equipment that you sell to the second company for $10,000. And then, of course, you still have to split the proceeds of that sale with all the excess shareholders, sells everything to the second company, liquidates, distributes the money and then dissolves, and then the second company can go on with business.
Speaker 2:
The reason I don't like to do them is that it can be a dishonest way to get rid of shareholders. It's a dishonest. It can be a dishonest way to get rid of shareholders and it can be used by unscrupulous people who might sell that $50,000 piece of equipment for $3 to the new company. So I'm reluctant to do them and I would say take care of people. They may not be happy with the result, but you want them satisfied. So you don't buy yourself a lawsuit just trying to do it in an unscrupulous way. But that's what a fire sale is.
Speaker 1:
So on a fire sale, if someone goes that route, are there different consequences or authorities that exist based on how they've structured the legal entity, like an S-corp versus an LLC or anything like that?
Speaker 2:
Not necessarily. There may be some statutory restrictions in the North Carolina code that protects minority shareholders. So that's something that, before doing a fire sale, you really need someone qualified like me to look into to see whether or not you'll buy yourself a lawsuit. There's a rule in North Carolina it's an old case law that says shareholders expect certain things out of a company. It says shareholders expect certain things out of a company and one of them is that the owners, the majority shareholders, the directors will deal with them fairly. So now the question becomes what is fairly?
Speaker 2:
Because if you own a share in IBM, you expect IBM is going to go out and sell computers and make money and pay you your dividend. It's the same way in a small company. A shareholder in a small company expects that at some point they might get some sort of dividend or increase in value in their shares. So when majority owners mess around with a fire sale, they're sort of treading that line between are the minority shareholders getting what they expected or are they getting jacked by the owners because the owners just want to get rid of them and um, which is why I try to discourage them.
Speaker 1:
Yeah, and you know we talk a lot about things. We talk about things a lot from the owner or manager perspective and everything but the shareholders, depending on what state they're in, is going to define what rights they have as a shareholder. Right, I mean, there's a federal umbrella, but every state has either organization or mess chaos based on their own state stuff. Isn't that right? Right?
Speaker 2:
Every state has its own Corporation Act or Limited Liability Company Act and I've worked in probably five or six different states Florida, Illinois, North Carolina. I won't go into New York or California because those states are just off on the moon somewhere, but there are noticeable differences between the statutes and between how each state treats shareholders, especially minority shareholders.
Speaker 1:
Yeah, yeah. So not only business owners when they're looking to go ahead and, you know, have a capital campaign based on, you know, selling off equity of the company, but also shareholders, when you're in, when you're invited to invest, go ahead and check your side of the equation too. On what kind of advise them on what the situation is. You say all the time better be prepared on the front end than deal with a crisis on the back end.
Speaker 2:
You can pay me a little bit now to do it right or a lot later to fix it.
Speaker 1:
Yeah, there you go. What's the best way for people to get in touch with you if they want to find out more about this? Talk to you about this or maybe some of the other things we've talked about in the series.
Speaker 2:
As always email. It's Palermo at Palermolawcom. That's also my website, palermolawcom, so they could punch that into the internet machine and find out more about what I do. But I'm certainly not limited to what's on my website. Any type of business transaction.
Speaker 1:
I can probably help with All right and congratulations again on the award for the podcast popularity.
Speaker 2:
That's awesome news and I'm sure some of your cohort are going to be very jealous. It is kind of cool. Number 11 in Illinois. Yeah, there you go. Not many people can say that.
Speaker 1:
Yeah, that's right. All right, so again, check out the information. If you're listening on a podcast, which a lot of you are, we'll have some information in the links. If you're listening on Biz Radio, just hit the little home icon and we'll get you connected that way. Thank you, michael. As always, you're welcome. See you next time.
