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A good friend of mine has a great idea for a project. He has more experience than I have, far more connections, and some awesome skill. He has some ideas on building tools for some major corporations, and I think the ideas have some serious legs.

His offer to me is that I would do the majority of the coding and he would be doing more of the client connections with some of the coding.

Based on his experience and connections, I don't really have a problem with 51/49 whereby he is the majority share holder, however I still want to protect myself in the event that something "could" go south.

So, based on the fact that he's more qualified to do the work, has the connections, and has the idea, I think that he's right in asking for 51%, however I just don't want to get screwed.

Can I get screwed as a minority share holder? Are there any pitfalls to this?

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Considering you're investing months of work upfron I don't think making you the minority shareholder is fair. – jsz May 20 '12 at 9:21

4 Answers

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As a minority shareholder, you need to be concerned about changes which affect you that you may not have any control over. However, it is not a huge deal to get around this, if you spend the time and money to get a properly drafted shareholders agreement.

In that agreement, you would put in statements about any kind of decision that you want to be able to control, at least to some level. So share dilution, approaching investors, dividends, buyouts and so on would all get their paragraphs.

As an example, let's say your partner wants to sell the company. You could put in a clause that says he has to offer it to you first (and how the price would be calculated). You could also put in a clause that says if he finds a buyer for his 51%, you have the right to force the buyer to purchase your 49% as well. Both of these are fairly routine clauses to draft, and they're designed to protect the minority shareholders.

As a note, the number of shares you own does not necessarily dictate the constitution of the board of directors. So you could also put in a clause that says that you get one seat personally, your partner gets one seat personally, and you have to mutually agree on the third (or whatever arrangement you want to make).

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Thanks for this. Looks like I'll probably accept the 49% but have a Shareholders Agreement drawn up with some decision making clauses. – Chase Florell May 20 '12 at 19:27
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need to see at the corporate level (it is a corporation, correct?) whether there are drag along or tag along rights. That would define the rights a minority shareholder has in respect to large decisions (buy outs, etc). vcorbust.com/hp_wordpress/2009/10/08/… – jimg May 22 '12 at 22:39
up vote 1 down vote

You absolutely can get screwed as a minority shareholder. The biggest concern is that the majority shareholder can take the company in a direction that you don't like, and you won't have any ability to do anything about it.

Typically, the way to deal with this is by requiring a super-majority vote to take certain actions -- typically, this would be things like selling more stock (i.e. diluting the minority down further), going into a new line of business, going out of business, and significant corporate transactions. That still gives the majority holder day-to-day control, but gives the minority a say over events that fundamentally change the deal he thought he was getting.

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up vote 1 down vote

Just put in your operating agreement that all decisions have to have an approval of all stake holders, regardless of the share split. You're small enough that you can do that.

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up vote 0 down vote

"A good friend of mine", I have found from experience that it's true that friends/ family and business don't mix. The fact that you're asking this question reveals the fact that you're uneasy about this venture from the get-go and you probably don't have anything yet.

There are several issues here. I wonder if anyone that has responded to this thread has been in any partnership, specially in a start-up environment, which is what this seems to be.

I have also played to role of the technical partner in a couple of joint ventures. You would be lucky to get a 51/49 partnership. It's not unfair if the partner with the idea has the 51% share. I would venture to say that you haven't sat down together to create a plan of everything that needs to get done to get your venture off the ground, let alone profitable or to a first round of investing. I say this because the first couple of ventures that I've worked on we didn't have a good grasp of the scope of everything that had to be done to develop a working product. There are calculators out there that can be used as guidelines, you enter variables such as, who came up with the idea, who performs what role, etc. Any venture that is worthwhile takes a lot of work. Where are you in life? Are you in college, single, family and is this a side project while you have a full time job? How long do you expect to be working on this before it becomes profitable? If you're working, at what point would you take the leap of faith to leave a stable income? Would both of you take that leap? I have seen the same mistake made by the technical and the less technical partner. You both don't realize how much work each aspect of the business entails. Imagine if all code was done. What next? what's the next iteration? It takes a lot of work to market, manage and develop business relationships. I have seen great products that have only 500 subscribers after six months because the founders did not know how to market. Once you have investors both of your stakes may start to dilute, specially early on if you offer a share of the business to lure good talent. Would that third person be a technical person or a business person? The best piece of advise that someone gave me about partnerships in start-ups came from someone who also had experience with several joint ventures. "You both need to get to know each other. Get out an get wasted and spent a lot of time together" You don't necessarily have to go out and get wasted but the point is that you relationship is key and very soon you will realize that the technical details fade away in comparison to how important your working relationship is. I hope some of this makes sense and helps. -adam

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