Issues with a Minority Sale

• They can result in a significant diminution of control. Even though the investor holds a minority stake, their rights can give them significant control over material future events such as expenditures larger than a certain amount, including the owner’s compensation, formingstrategic alliances, incurring debt, selling future equity interests, and on and on. And they nearly always involve giving up one or more board seats to the investor.

• They can result in a significant loss of future economics. For instance, if the investor is given a preferred return, which can be accomplished in several ways, that return can dilute the owner’s economic upside on a future sale of the entire company.

• They almost always restrict the owner’s ability to sell the whole company in an unrestricted manner in the future. For instance, the investor may demand a right of first refusal on any offer or right of first offer that severely limits the owner’s ability to market their company in a ‘free market” way that attracts top dollar.

• They are extremely difficult to unwind. Just as with a married couple, when permanent separation is the goal, the interests of each party are not aligned. Litigation is a very real possibility.

• They nearly always involve divergent interests. An owner has a diverse number of reasons for owning their company (e.g., earning a financial return, doing right by employees and customers, having fun). But investors usually have more limited reasons for investing. For example, an owner may decide they want to open a division in the Bahamas because they like the Bahamas and believe they can earn a reasonable return with that strategy. An investor, though, guided by a pure return-on-investment mindset, may believe that there are many other locations more appropriate for expansion.

The demand for minority interests is relatively robust right now. This is driven first by the extremely large amount of capital, “dry powder,” held by investors. And second by the intense shortage of executive talent to lead their investments. Investors like situations that involve the retention of management, which minority sales do, by definition.

If a minority investment is interesting, we suggest an intense, deep dive into the terms that will be negotiated in such a deal. They likely define the difference between a really good alternative to an outright sale and a really challenging and a bad marriage.

Next: The Critical Terms of a Minority Investment

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