Squeeze-out Mechanisms and Minority Shareholder Protections

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Posted: November 15, 2024
Jacob Mallinder
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Shareholders are deeply involved in a company's decision-making processes and have the ultimate power to make key decisions. They are generally categorised into two groups: minority shareholders and majority shareholders. The interaction between these two groups is central to keeping a corporate environment healthy and harmonious. But what happens to minority shareholders' company shares during mergers or acquisitions? And can you force a minority shareholder to sell their shares? This article will answer these questions.

What are mergers and acquisitions?

Mergers and acquisitions (M&A) are transactions that bring together two businesses. A merger is usually the combination of two firms of about equal strength, an acquisition is the purchase of one company by another—typically a bigger one buying a smaller one. Often used interchangeably, depending on the terms of the business deal they differ. The situation is regarded as an acquisition If a company does not wish to be taken over by another.

The difference is often shown in how the employees, board of directors and shareholders learn about the merger or acquisition. However, many merger and acquisition situations are mutually beneficial and allow companies to grow their presence and expand their reach. Some more differences between them include:

  • Business name: The company acquiring the other usually maintains its business name, legal structure and operations. In a merger situation, the companies involved may choose a new name or use one of the existing company names to maintain brand awareness and loyalty.
  • Legality: From a legal standpoint, a company acquired by another company ceases to exist under its previous legal entity. If the acquired company sells or trades stock, the stock is owned and managed by the acquiring company.

Majority and minority shareholders during M&A

A shareholder in a company undergoing a merger may receive shares in the new company. A shareholder in an acquired company will receive cash for the stock or shares in the acquiring business. Share value in the acquiring company may change for better or worse. After the M&A transaction ownership percentages might be rearranged.

A majority shareholder is an individual or entity that holds more than 50% of the total outstanding shares of a company's stock. Majority shareholders are known for their essential role in decision-making processes, making them an essential element in complex corporate ownership and management. The most important majority shareholder responsibilities are:

  1. Voting. They reserve the ability to cast their vote to elect the board of directors, approve major transactions, and shape the company's strategic direction. Such privileges enable them to exercise significant influence over the corporate governance of the company.
  2. Board representation. Majority shareholders often benefit from appointing their representatives to the company's board of directors. These board representatives can advocate for their interests and ensure company policies align with their goals.
  3. Dividend decisions. Majority shareholders also influence the distribution of dividends to shareholders. The amount and timing voted impact the return on investment for all shareholders.
  4. Asset sales and mergers. When a company sells assets or merges with another entity, majority shareholders can approve or veto such transactions. This power can help protect their interests and shape the company's future.
  5. Corporate strategy. Some of the changes like business operations changes, expansion plans, or cost-cutting measures that align with their objectives may be advocated by them. Their actions also affect company decisions such as capital allocation, investments in research and development, or acquisitions.

Minority shareholders hold less than 50% of a company’s shares. Despite their smaller ownership percentage, they still have certain legal rights that protect their interests within the company. Minority shareholder protections include:

  • Information rights. Minority shareholders can suspect the board of directors managing the business properly. In practice, one of the most important provisions for a minority shareholder is the right to access financial records and management accounts.
  • Power of veto. Minority shareholders can change the articles or shareholder agreements and be given the power of veto. A minority shareholder can have the power to block business sales and mergers, expenditure above prescribed limits, winding up or voluntary liquidation or large-scale investment.
  • Dilution of shares. Under the Companies Act shareholders can subscribe for shares under any new share issue. Minority shareholders should look at dilution and building in protection when they invest.

Squeeze-out mechanisms in merger

After a merger minority shareholders may no longer fit into the new structure and are thus squeezed out. A squeeze-out is the compulsory sale of the shareholding of minority shareholders of a company to an acquirer or majority shareholder. This technique allows one or more shareholders who collectively hold a majority of shares in a corporation to gain ownership of the remaining shares in that corporation, often following a merger or acquisition.

The legality of minority squeeze-outs can be complex and heavily dependent on the specifics of each situation, affected by state and federal laws governing corporate conduct. Commonly, while majority shareholders have the right to make decisions that could materially affect the company's future, they must also act fairly toward all shareholders. Actions to squeeze out minority shareholders should be done correctly to be legal.

One more question to answer — can a minority shareholder force a buyout? A forced buyout of minority shareholders happens if the applicable law or an existing contract allows it. However, a careful facts review and contracts at play can immensely change the outcome of your actions.

Conclusion

Conducting M&A transactions is a complicated process and requires following all legal regulations. A squeeze-out occurs when majority shareholders in a company try to deprecate, reduce, or entirely terminate the ownership stake of minority shareholders. Understanding squeeze-out mechanisms and shareholder rights in squeeze-out transactions is important for fair and transparent deals that protect the interests of all parties involved.

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