Finance Monthly May 2019 Edition

39 www.finance-monthly.com SPECIAL FEATURE - STOCKHOLDER DISPUTES corporation. While there may well be a market for an entire closely held business, it’s unlikely that potential buyers will be lining up to acquire a portion of the stock in such an enterprise. As a result, stockholders in close corporations, especially minority stockholders, face serious obstacles in monetising their interests for a price consistent with their expectations of the stock’s value. There are several reasons for these obstacles: • Even if organised as a corporation or limited liability company, a closely held company is almost like a partnership with only a few owners. A stockholder seeking to sell their stake must find a buyer who is willing not only to assume the risk of owning a piece of a business but will do so by partnering with people they may not even know; much less trust. • Corporate stock may be subject to the corporation’s right of first offer or right of first refusal. This will further dampen the market for the stock. • Close corporations frequently operate without the financial transparency required of public companies. This makes it difficult for an outsider to ascertain the value of the business and, by extension, its stock. • Finally, the goodwill of a close corporation is often tied up with the reputations of and relationships nurtured by its founders. Their exit (or potential exit) from the business is a risk that negatively affects price. So, who then might comprise the market for a closely held company’s stock? Usually, the pool of possible buyers will be limited to insiders, e.g., existing stockholders. The lack of competitive bids from outside parties gives insiders a lot of negotiating leverage, especially vis-à-vis minority stockholders. If the insiders are already receiving substantial financial benefits from the business (salaries and benefits, dividends, and perks), they may not leap at the chance of a larger stake, unless it would materially increase those benefits or come with full control of the business. In other words, the insider’s perception of the stock’s desirability and value will be driven by the potential incremental benefits of owning the additional stock. A seller may not have any better options than what the insider is offering, and that engenders resentment. There are ways to resolve these disputes short of civil litigation if the parties are willing to compromise, in writing, as early in the life of the company or in their stock ownership, as possible. Founders and later stage equity holders alike are well advised to sort out their valuation options before any party has started to think about an exit plan by, among other things, crafting creative buyout agreements and stock valuation mandates in the corporation’s articles and bylaws. While they do not eliminate all litigation risk - bylaws and other agreements providing a stock valuation process are subject to interpretation by lawyers and appraisers - they do mitigate that risk and provide for a faster resolution. And at the end of the day, they may just save your personal relationships. Euripides Dalmanieras, Partner at Foley Hoag | www.foleyhoag.com