25 Feb Guidelines for Minority Partners
I’d like to take a moment to talk about disparate or unequal ownership shares in a business.
Over the last couple of months, I’ve encountered a couple of family businesses as current and potential clients. It is common for a one owner to give a smaller share of the business to family members. In one case, the parents gave their daughter a small share of the business to help her learn about business operations and start a nest egg. The other scenario was two brothers who were wanting to have their parents own a small share of the business to help supplement the parents’ retirement income.
There is nothing wrong with setting up an organizational structure where there is a mix of majority partner(s) (more than half the share) and minority partner(s) (less than half the share). There are some legal aspects to it. All partners and members have a statutory right to review the books so they can understand what’s going on. They have some rights when it comes to the sale of the business, assets, and matters involving voting and management rights.
But, really what I want to talk about is what number one should assign to a minority shareholder that can provide as much protection as possible. Oddly enough, that number is 19.
As a general guideline, if you are going to go to a bank of any size to borrow money for the partnership, most banks (not all banks) require that persons owning 20% or more of the business personally guarantee the loans.
When small business owners borrow money, they are not borrowing on the credit of the business, but rather on the business owner’s credit. The question is at what point does the bank require minority partners to be involved in guaranteeing a loan? Typically, partners that own 20% or more will have to sign a personal guarantee
If a minority owner has 19% or less of the business, then typically that person would not be required to guarantee the loans of the business. This is a key component. When you are structuring a business with a minority partner, recognize that people with 19% or less of ownership share do not carry the same financial risk that larger shareholders carry because they will not be asked to guarantee loans.
That 19% guideline is not a hard rule. Each bank has its own underwriting and policies requiring lending to partnerships.
Conversely, the minority partner might be the best person to guarantee a loan. A minority partner may actually be in a better position to guarantee the loan because they may have better credit or assets available. Just because they are a small shareholder does not mean they can’t guarantee the loans, it just means that the bank may not require them to do so.
Be a little creative. Small investors might be in a position to offer more money or security for a small business getting started.
Have lingering questions on how to divide ownership shares? Contact us anytime.