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Can My Investors Take Over My Small Business?
Many San Diego small businesses seek out investors to help start the business, but there is often some confusion about what role the investor plays and what rights the investor has. One common concern for small business owners is whether an investor will have the power to take over a startup? The answer is: it depends. Under most agreements or pursuant to legal process, “losing control” is typically only relevant to a failing new business, and a growing and thriving business would not be susceptible to an investor takeover. Here is a quick discussion.
San Diego Corporate Law: Ownership of Small Businesses
In general, business corporations are owned by their shareholders. The shareholders own the assets of the corporation and meet at least once a year to elect the people who make decisions for the business. These are called directors. With small businesses, the shareholders often elect themselves as directors.
The directors in turn hire the President or Chief Executive Officer and the other members of “upper management.” These folks actually run the business day-to-day. Again, shareholders can be hired as the President/CEO and this is often the case for small new startup businesses.
An investor cannot “take over” your business unless the investor owns or controls a majority of the shares of stock and/or the control of a majority of the seats on the board of directors. It is not enough to “take over” to be hired as the President/CEO. This is because, as noted, the President/CEO is hired by the board. As such, the President/CEO can be fired by the board if he or she goes against the wishes and directives of the board.
The foregoing is true for other types of corporate entities. A limited liability company (“LLC”), for example, is owned by its “members” who either manage personally or elect/appoint “Managers.” The Managers might run the LLC day-to-day, but might also hire a President/CEO. To “take over” an LLC, an investor would need to control a majority of the percentage ownership or units.
Because of how companies are owned, an investor cannot “take over” your new business unless there is an agreement or legal process. We discuss agreements next.
San Diego Corporate Law: Agreements Allowing an Investor Control of Business
Some investors insist — as a condition of the investment — that they have some amount of control over the company. These conditions are set out in the investment agreement. As an example, an investor might demand turnover of some percentage of the shares of stock (or, more often, the right to vote the shares of stock), or some specified number of seats on the board of directors. If the investor has a majority of the shares — or the right to vote a majority of the shares — then the investor can elect the board and can “take over.” Likewise, if the investor is given a majority of seats on the board to control, the investor can “take over.”
Note that it is rare for an investor to ask for control of the company at the initial stage. Generally, certain conditions are specified in the investment agreement for when control is shifted to the investor. An example of such a condition might be the failure of the startup business to reach target sales and/or revenue goals. Of course, as the owner of your new startup business, you do not have to agree to such demands in exchange for the investment. If you are considering agreeing to such, you should have the agreement reviewed by an experienced and competent San Diego corporate attorney.
San Diego Corporate Law: Judicial Process Leading to Loss of Control
Finally, there are lengthy legal proceedings that might lead to the loss of control of your business. For example, if your business becomes insolvent, there are mechanisms by which your creditors — like an investor — can force your company into bankruptcy. As part of those proceedings, your investor might be awarded control or ownership of the company.
Contact San Diego Corporate Law
For further information, please contact Michael Leonard, Esq. of San Diego Corporate Law. Mr. Leonard has the experience to help you deal with investors, draft or review any contract related to an investment, can assist you with forming form your new corporation, keep your corporation in good standing, and can create and assist in executing business contracts. Contact Mr. Leonard by email or by calling (858) 483-9200.
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