Minority Business Ownership in a Small Business: A Dream Fulfilled or a Nightmare Created?

posted by Joseph Spoonster  |  Dec 21, 2011 4:00 PM in Business Litigation

Minority Business Ownership in a Small Business:  A Dream Fulfilled or a Nightmare Created?                           

A big part of the American Dream is to own a business. To achieve this dream, many owners start a business with one or more “partners” who are employees and share equally in the profits as owners.  This dream can turn into a nightmare, however, if the relationship sours, since employee ownership can be more difficult to unwind than a marriage.

Whether as partners, members, or shareholders, the owners owe one another “fiduciary” duties so that none of them gain personal profit at the expense of the business. They also may not participate in activities that directly conflict with the business’ interest.  For example, an owner cannot compete against the business for its business prospects.  The law also says that the “majority” or controlling owner has a “heightened” fiduciary duty requiring that owner to act with the utmost good faith and loyalty to the other owners.

This heightened fiduciary duty requires the majority owner to consult and inform the co-owners as to all ownership matters.  It also gives minority owners an equal opportunity in the business.  For example, the majority owner cannot take an excessive salary or bonus, use the business to pay for personal expenses, or charge the business high rent for the majority owner’s property. 

An owner/employee business relationship can sour when one owner develops a greater role in the success of the business or takes on more responsibilities than originally planned.  Gradually, the other owner’s role and participation diminishes.  Meanwhile, each is entitled to the same share of the business profits. 

The controlling owner might consider several ways to correct this inequality, each of which is fraught with liability.  First, the controlling owner might fire the non-performing owner.  However, owner/employees are not “employees at will” and cannot be removed without a legitimate business justification.  Second, the controlling owner could deprive the non-performing owner of an equal opportunity in the business, hoping he or she quits.  This is a classic “freeze-out” or “squeeze out” that courts have found violate the fiduciary duties.  Finally, the controlling shareholder might close the business and set up a new one, leaving the non-performing owner behind.  This is also a violation of fiduciary duties as one owner has taken all of the business opportunities in a competing business. 

The law provides no easy way to remove an owner who is no longer contributing to a business.  At most, the controlling owner can dissolve the business in court, dissolve it according to the business regulations or bylaws if they allow for dissolution, or buy back the non-performing owner’s interest. 

Deciding to share business ownership is a very important decision.  Oftentimes the potential for future conflict arising from personality or business issues are not considered when the partnership is formed.  Parties often do not create ways to resolve potential conflicts or remove a non-performing owners.  Partnership, operating, shareholder, and employment agreements can offer some help, however, and careful consideration should be given to crafting such agreements to include provisions that address these issues.  

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Michael Fortney Neil Klingshirn Joseph Spoonster
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