The legalities of having stockholders
By Cliff Ennico
“My brother and I started a small retail business 10 years ago and it’s done very well since then.
We always wanted this to be a family business, so several years ago we sold 25% of our company’s stock to five family members, none of whom are actively involved in the business (although we have given their kids summer jobs every once in a while).
One of these stockholders died last year and left his stock to his three children. One of these children sent us a nasty letter recently demanding that we show our books and records to his accountant and accusing us of all kinds of nasty stuff. One of his more interesting allegations is that we’ve never held a meeting of stockholders since the company was formed.
My brother and I didn’t think this was a requirement, especially for a small business like ours where everybody knows everyone’s business anyway. We have never paid dividends on our stock, which is I think what this kid wants. How should we deal with this situation?”
From your e-mail I am guessing that your business is set up as a corporation – if it’s a limited liability company (LLC), the rules here may be slightly different.
You made two serious mistakes when you sold a piece of your company to “friends and family” years ago. The first is that you sold them shares that had voting rights. Voting shareholders in a corporation have tons of legal rights under state corporation laws, including:
- The right to call a shareholders’ meeting at any time (if they hold at least 10% of the shares);
- The right to inspect the company’s books and records;
- The right (in some states) to see your annual financial statements and tax returns; and
- The right to approve certain major corporate decisions such as mergers, acquisitions, offering of preferred stock, and amendments to the company’s charter.
You should have issued them nonvoting shares that would have given them only a right to a percentage of the profits and losses of the business.
The second mistake you made here (I suspect) was not having your stockholders sign a “stockholders’ agreement” or “buy-sell agreement” restricting their ability to transfer shares to other people. That would have given you the right to buy back some or all of the shares your deceased family member left to his children, reducing the possibility that one of them would turn into a “rabble rouser.”
Take a look at your company’s bylaws (there should be a copy in the minute book your lawyer gave you when he set up the company). There probably is a provision in there requiring you to have a meeting of stockholders at least once a year, usually at a specific time of year. Even though the meeting can be held informally (most states now allow meetings by telephone conference calls and online Skype calls), it’s something you just gotta do.
When you first started this business, it was just you and your brother, so not having the meeting wasn’t a big deal – the two of you could have just gone out for a burger and had the meeting at McDonald’s. Once you brought in outside stockholders, though, you started having duties to them. And one of those duties was to have a meeting at least once a year to let them know how things were going. If they didn’t show up at the meeting, that was their decision.
So why is this stockholder so angry and giving you headaches? The answer, I think, lies in your message. You say at the very beginning that the company has “done very well” – meaning, I think, that it is currently profitable – yet at the very end you say you have “never paid dividends” to your outside stockholders.
If I am right, this stockholder is probably upset that you have been using all of the company’s profits to pay yourself and your brother salaries, leaving nothing left over for your outside stockholders. He wants to see the company books and records so he can determine whether or not your salaries are “reasonable” given the nature of the business, what other similar companies pay their officers and directors, and so forth.
While a corporation’s directors are never legally required to pay dividends to stockholders – they do so entirely in their “business judgment” which is protected by law – operating a company as if it were your personal “piggy bank” can get you into a lot of trouble with stockholders. I would recommend that you call a shareholders’ meeting now so your disgruntled relative can air his grievances and you can get to the bottom of exactly what’s bugging him. There are strict legal rules as to how the meeting should be conducted (for example, all stockholders must receive at least 10 days’ advance notice of the meeting in most states), so talk to a competent business attorney before scheduling the meeting.
Cliff Ennico (firstname.lastname@example.org) is a syndicated columnist, author and host of the PBS television series ‘Money Hunt’. This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our Web page at www.creators.com. COPYRIGHT 2016 CLIFFORD R. ENNICO. DISTRIBUTED BY CREATORS SYNDICATE, INC. @.