Why is it worth owning < 50% of a private company? E.g. when investors invest in private companies and get less than 50%, or when employees of startups get small chunks of a company, couldn't the owners just put the profits into higher salaries for themselves, assets, etc.? When would the < 50% owners ever benefit? Assume that they are not in a position of ability to pair up with other owners and form a majority to use their voting rights.
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3 Answers
Majority shareholders of private corporations have a lot of power, but it usually isn't unlimited. Limits on majority power may be imposed by the articles of incorporation. So, if you are thinking of becoming a shareholder you'll definitely wan't to have a lawyer review the terms of your purchase and the governing documents for the company. In addition, many jurisdictions impose fiduciary responsibilities on all the owners of a private corporation. As an example, here is an article on the fiduciary obligations of shareholders in privately held corporations in Illinois USA. Requirements of fiduciary responsibility may not save you from sharp dealing by the majority shareholders, but they at least gives you a leg to stand on when fighting against negligence or dishonesty.
answered Nov 27, 2017 at 18:34
The board of directors is ultimately in charge of setting the budget, dividends, salaries, etc. Often the board is made up of people who are stockholders themselves and are not employees drawing a salary. As a result, they have an incentive to maximize the profits of the company.
answered Nov 27, 2017 at 4:52
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I understand that is true for a public company, but what about small private companies with just a single owner with > 50% of the company? Commented Nov 27, 2017 at 5:29
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8@AdamThompson You can certainly concoct a scenario where an investment is a bad idea. And if you don't trust the founder/majority stockholder, I would say that would be a bad investment. And yes, private corporations do generally have boards of directors. Commented Nov 27, 2017 at 5:31
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When investors invest in small companies for < 50% ownership such as in a show like Shark Tank, how do they know that the people they are investing in won't just put all the profit into their own salary? They don't know/trust the major stockholder because they do not know them. Commented Nov 27, 2017 at 23:25
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@AdamThompson Shark Tank is TV. What you see on the screen doesn't necessarily correspond to what eventually happens. According to a Forbes report, only a quarter of the deals were consummated according to the terms agreed to on the show. Also the deals aren't made in real time. The investors have plenty of time to do due diligence on the companies. Commented Nov 27, 2017 at 23:49
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1@AdamThompson For the answer to that question, see If a startup receives investment money, does the startup founder/owner actually gain anything? Commented Nov 27, 2017 at 23:59
...couldn't the owners just put the profits into higher salaries for themselves, assets, etc.?
Yes, they definitely could, but that doesn't mean they will. Regarding employee stock, most (but certainly not all) small business owners that become successful take great pride in their employees, and feel that the company has grown as a result of having great employees. They therefore choose to return some amount of profits to their employees as a thank you, and also a motivator to help obtain and retain good talent.
The same is also true for outside investors, but to a lessor extent. If the company becomes known for greedily spending its profits in a way investors disagree with, they will lose interest. This will make it harder for the owners to obtain future investments or cash out on existing ones if they ever wish to sell their shares. This doesn't preclude the owners from completely taking advantage of the original set of investors though.
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Right, that makes sense for a company with
namount of people asngets large, especially as this knowledge could spread. I'm more thinking along the lines of <10 people investing in a company. For example, if 3 people owned shares in a company, one person 51%, the others at 24.5%, then it could be easy for the one person owning 51% to extract all the profits via putting it all into salaries and the other shareholders could not legally do anything as no profit is being generated. Commented Nov 27, 2017 at 23:30 -
3>then it could be easy for the one person owning 51% to extract all the profits It is possible, but 'easy' is overstating it. The minority shareholders are usually not powerless. For example, if the majority shareholders pay absurd salaries to unqualified relatives the minority shareholders may be able to make a case for breach of fiduciary duty and take the company away from the majority shareholders. If the minority shareholders simply disagree with the business decisions of the majority, then they are probably just stuck with it. Commented Nov 28, 2017 at 0:01
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2@AdamThompson - Case in point, there is a CEO who is a majority shareholder and his brother is a minority shareholder. They had a disagreement and the CEO increased his salary from $50K to over $1M to spite his brother. His brother sued him, and worried he might lose, the CEO lowered his salary back down and spent all the company profits by increasing all employee salaries (to further spite his brother). He had a good run for a while and was considered a hero in the business world for seemingly being so nice to his employees, until later when it was revealed why he did it.– TTTCommented Nov 28, 2017 at 3:51
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@TTT thanks, didn't realize you couldn't just increase your salary to unlimited heights. Great example. Commented Nov 28, 2017 at 5:41