When you have multiple stockholders you typically have a stockholders’ agreement in place that all stockholders are required to sign. That will usually have what’s called a drag-along provision which states that if the majority of stockholders either approve a sale transaction, everyone else is required to go along with it. If you have a transaction that meets the requirements of the drag-along provision, the minority stockholders will have to go along with the deal or they’ll be in breach of contract and can get sued by the majority stockholders.
Drag-along Provision Ensures Everyone Goes Along With the Deal
Usually the minority stockholders will cooperate with the decision, but sometimes they dissent. I’ve seen situations where majority stockholders have had to write nasty letters with inflammatory language to minority stockholders to remind them of the drag-along obligation. At this point, the minority stockholders usually go along with it because they legally cannot stop the deal.
Mergers Are Often Used to Avoid Delaying a Deal
If there is either no stockholders’ agreement or no drag-along provision, the parties will structure the deal as a merger specifically to avoid this issue. The way a merger is structured, unlike a stock purchase, you do not need each and every stockholder to sign the purchase agreement. This way a minority stockholder does not have the ability to delay the deal.
The merger itself typically only has to be approved by a simple majority of target’s stockholders. By operation of law, all the stockholders stock in the target gets converted into the merger consideration including the minority stockholders’ so they are basically along for the ride, regardless of whether or not they agree with the deal.
Appraisal Rights Allow Minority Shareholders to Obtain Fair Value
The recourse dissenting minority shareholders have is in this situation is appealing for appraisal rights. They can apply to the court in their state and bring an action to obtain fair value for their shares if they feel the merger consideration is not fair value.
In most cases this occurs only when the target’s majority stockholders are selling to a related party and are trying to squeeze out the minority stockholders for what is not fair value. In that case, the minority equity holders can launch a claim and object to that. A recent high-profile example of appraisal rights is the ruling in the 2013 Dell buyout.
Typically in the merger agreement itself, there will be a closing condition for buyer that no more than 5-10% of the target’s stockholders will have dissented and sought appraisal rights as part of the process.
Having done hundreds of deals, it is extraordinarily rare to see appraisal rights invoked. You may have one to two minority shareholders in a larger publicly-traded transaction who choose to exercise this option, but in a smaller deal you usually don’t see this. In short, if most of the equity owners are on board, the deal ends up happening.
* This question and answer above come from the Capstone Webinar “Contemporary Legal Issues in M&A” with M&A attorney John McDonald. Learn more and register for upcoming webinars on M&A U™.
