By Travis Townsend Jr.
Are you a part owner of a limited liability company, but on a minority ownership basis? If so, there is one very important hazard that you should remain vigilant about at all times. I’m talking about the squeeze play. The squeeze play is when majority owners of a business take advantage of their decision-making power to exploit the business for their personal benefit to the detriment of minority owners. It doesn’t get much worse than having invested hard earned money into a business all to become completely powerless when it comes to the benefits of that business.
Most LLCs act based on a majority rule basis. A majority of the members will choose the company’s managers. While all managers have a duty to act in the best interest of the company, sometimes managers take action in favor of the members who elected them. Many times the managers and the members who elected them are one in the same because members will elect themselves as managers. Managers have the authority to, among other things, elect officers, determine salaries, and to decide if and when dividends are paid out. Thus, the holders of a majority of the business’ ownership control the business for all intents and purposes, and can exert that control so much that it completely devalues the minority ownership.
One common manifestation of the squeeze play causing minority ownership of a company to be worthless is when managers have appointed themselves as officers, have refused to declare and distribute dividends, but have established huge salaries and bonuses for officers of the company. Majority owners who are also officers receive the pecuniary fruits of the business’ successes via salary, while the minority owners who are not employees do not receive a dime because they do not receive salary and no dividends are paid to the owners. If you see large salaries getting paid out and no indication of any dividends coming, look out, you might be in the middle of a squeeze and there may be more squeezing to come.
Another materialization of the squeeze play is when majority owners deprive minority owners access to key information. Many states require companies to deliver key information to all owners, but not every state does. In such states, the squeeze may take place by preventing minority owners from knowing how profitable the company is; thereby limiting their ability to claim deserved monetary returns on their investments.
Sometimes the squeeze play ends in a squeeze out. Majority owners may exploit their controlling position to transfer valuable assets of the business to another business owned solely by them, in so doing, decreasing the value of the minority owners’ investment in the original business almost to nil. The majority owners can then continue the same profitable business operations under a new company, without the minority owners tagging along.
So how do you protect yourself from the squeeze play? The first step is to include protective provisions in your company’s governing documents. Be sure to require some minority say in the sale of assets. Add information requirements in them also. However, if that doesn’t provide enough protection, minority owners can head to the courts for relief by either bringing law suits on behalf of the company claiming that management actions are in violation of their fiduciary duties to the company, suing management directly for fraudulent actions.
When the squeeze is on, things can get tight. But if you are attentive you can avoid this common business trap.