Q: My brother and I started a small retail business 10 years ago, and it has done very well.
We always wanted this to be a family business, so several years ago we sold 25 percent 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 family members died last year and left his stock to his three children. One of them sent us a nasty letter recently, accusing us of all kinds of nasty stuff and demanding that we show our books and records to his accountant. One of his more interesting allegations is that we've never held a meeting for stockholders since the company was founded.
My brother and I didn't think this was a requirement, especially for a small business like ours where we all know one another's business anyway. We have never paid dividends on our stock, which I think is what this kid wants. How should we deal with this situation?
A: I am guessing that your business is set up as a corporation. If it's a limited liability company, the rules may be slightly different.
You made two serious mistakes when you sold a piece of your company to family members. The first is that you sold them stock that gave them voting rights. Shareholders with voting rights have tons of legal rights under state corporate law, including:
—The right to call a shareholders meeting at any time (if they hold at least 10 percent of the shares).
—The right to inspect the company's books and records. (In some states, they have the right to see the company's annual financial statements and tax returns.)
—The right to approve certain major corporate decisions, such as mergers, acquisitions, offerings of preferred stock and amendments to the company's charter.
You should have issued them nonvoting shares, which would have only given them rights to a percentage of the profits and losses of the business.
The second mistake you made (I suspect) was not having your stockholders sign a stockholders' agreement or a buy-sell agreement to restrict their ability to transfer shares to other people. Otherwise, you would've had the right to buy back some, or all, of your deceased family member's shares, therefore averting the possibility of his child becoming 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 is probably a provision requiring you to have a stockholders meeting 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 via conference call or Skype call), it's something you just gotta do.
It was just you and your brother when you first started this business, so the meeting wasn't a big deal — you could have just had the meeting over a burger at McDonald's. By bringing in outside stockholders, though, your duty is to hold a meeting at least once a year to tell them how things are going. If they don't show up to the meeting, that's their decision.
So, why is this stockholder so angry and causing you headaches? You said that the company "has done very well," meaning (I think) it is currently profitable, yet at the very end you say you have "never paid dividends" to your stockholders. If I am right, he is probably upset that you and your brother have been using all of the company's profits to pay for your salaries, leaving him empty-handed. He wants to see the books and records to determine whether or not your salaries are reasonable, to gauge what similar companies pay their officers and directors, and so forth.
While directors of corporations are never legally required to pay dividends to stockholders — according to the business judgment rule, 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 the issue. There are strict legal rules as to how the meeting should be conducted (for example, all stockholders must receive at least 10 days' notice in most states), so talk to a competent business attorney before scheduling the meeting.
Cliff Ennico ([email protected]) is a syndicated columnist, author and former 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.