The Unseen Challenges: Safeguarding Minority Sellers in M&A

In the high-stakes world of mergers and acquisitions, minority shareholders must proceed judiciously. While transactions may have the power to reshape entire industries and create tremendous value, such arrangements can be particularly tough for those individuals with smaller stakes in the company being sold.

The Power Struggle

The ultimate determinant of the minority seller’s predicament is a fundamental power asymmetry. Limited voting rights and sparse representation involving important decision-making bodies generally cause minority sellers to battle to influence crucial aspects of the M&A process. That absence of control also extends away from the negotiating table and can leave a drought of vital information on matters such as company valuations, strategic plans, and details of the transactions.

In turn, the haste of many M&A deals compounds this problem further with little residual time for minority sellers to seek professional advice. The information asymmetry can result in mistrust because such shareholders worry that details of suspected or actual manipulations engineered against them are also being withheld.

Difficulties that Minority Sellers May Face

The economic and legal challenges to the minority sellers in a private M&A deal are manifold, particularly in more complex transactions featuring equity rollovers.

Transaction structuring often focuses on the tax and other needs of the primary parties to the transaction, such as the purchaser or the controlling shareholder of the target. The individual tax planning needs of a particular minority seller will likely not drive how an M&A transaction is structured. The complexity of private company M&A structures may require such minority sellers to retain capable legal counsel (with a deep bench of proven skill in corporate and tax law) to help them understand any risks the structure might create.

Minority sellers may also have interests beyond just the financial return inherent in the transaction. For instance, if a minority seller either needs to, or would like to, continue working after closing in the same industry as the target company, then he/she may have special sensitivities involving non-competes and other restrictive covenants. Even in states like California that limit post-employment non-competition agreements, sellers in an M&A transaction can be bound by such restrictive covenants post-closing. Such terms can limit the financial and lifestyle decisions of minority sellers in ways that may be less relevant for a controlling shareholder.

A minority seller may also be asked to rollover their equity. A rollover occurs when a shareholder does not sell all of their equity in the target company but retains some of that equity in the enterprise following closing. Buyers often rightly value rollovers because they ensure sellers retain some skin in the game post-closing. However, the terms of a rollover may be primarily driven by negotiations between a controlling seller and the buyer, which might leave minority sellers with rollover terms they would not have bargained for or terms that differ from those of the controlling seller who may benefit from specially negotiated side letters.

Timing and Priority Mismatch

Minority sellers who also work for the company being sold often face an additional timing mismatch with respect to the documents that could matter the most for them. The controlling shareholder seller and buyer are rightly focused on the major terms of the underlying M&A transaction. For those parties the employment agreements and restrictive covenant agreements of minority sellers are an ancillary agreement which means they might often be a last second negotiating item. This can result in a minority seller being jammed on timing to protect themselves.

There is also a divergence of interest if the controlling shareholder is not required to sign an employment agreement or restrictive covenant agreement. Private equity funds rarely – if ever – will agree to be bound by restrictive covenants given their position as a provider of capital to various portfolio companies. In such situations the need for independent review of these documents is all the more acute for a minority seller.

Independent counsel for a minority seller can seek to have the controlling shareholder and buyer start negotiations on employment agreements and restrictive covenants sooner. Independent counsel can also better provide confidential advice that would not be shared with other sellers. This can avoid a situation where a minority seller finds themselves looking at an unfamiliar but fundamental agreement on the same day they are asked to approve the transaction.

The Path Forward

Although major hurdles exist, minority sellers still have some options for protecting themselves. They may need to take action by retaining professional guidance to protect their interests and secure a fair outcome in an upcoming M&A transaction.

The first step is to assess whether the transaction requires independent counsel and, if appropriate, retain experienced legal counsel at the onset of the deal. Independent legal counsel can help assess possible risks unique to the minority seller, as well as negotiate more favorable terms. Independent counsel can also provide solutions to the myriad issues associated with voting rights and shareholder agreements while also gaining as much influence and protection as possible post-closing.

Another key tool is proactive communication. Through actively seeking information and establishing clear channels for expressing minority seller concerns, the seller more effectively ensure that their voice is heard throughout the M&A process.

The world of M&As is often daunting for minority sellers. However, by retaining experienced and proven M&A counsel, understanding the challenges such stakeholders face and taking proactive steps to address these roadblocks to progress is far more easily achieved. With the right independent legal counsel who will engage in careful planning and advocacy of their interests, minority sellers are assured their point of view is considered and their rights are safeguarded across even the most complex M&A scenarios.

Stradling Partner, Alidad Damooei, represents public and private companies, minority stakeholders, private equity funds, independent sponsors, and founders involved in domestic and cross-border mergers and acquisitions across all types of industries. If you have any questions regarding minority stakeholder representation or any other issue involving M&As, fund formation, PIPEs, rollovers, or joint ventures, he can be reached at (805) 730-6832, (424) 214-7000, or by email at adamooei@stradlinglaw.com.

Stradling Partner, Ryan Gaglio, is an experienced tax lawyer who helps his clients achieve their business goals quickly and efficiently. He is a go-to advisor and problem-solver for public companies, private equity funds, venture-backed/early-stage companies and family offices who rely on him to consider their objectives carefully and design strategies tailored to their risk profile. His practical and actionable solutions enable his clients to confidently understand the tax consequences of mergers and acquisitions, bankruptcies and workouts, estate planning, real estate holdings and executive compensation structures. He can be reached at (949) 725-4042 or by email at rgaglio@stradlinglaw.com.