Private Equity Deals: Do Minority Shareholders Have to Go Along?
Owners of private practices are divided on the matter of practice sales to private equity (“PE”) firms. Whereas more senior shareholders tend to view PE sales in a favorable light as attractive cash out opportunities, more junior shareholders tend to see such sales in an unfavorable light as reductions of future compensation and loss of control. That said, younger shareholders typically feel pressured to (or believe they are required to – although in some cases they are) go along with the majority owners and agree to the PE deal. However, minority shareholders are not necessarily required to accept PE sales.
Most states have laws that provide minority shareholders with dissenters’ rights (or appraisal rights). Generally, these laws permit minority shareholders to invoke their dissenters' rights to a proposed corporate transaction involving sale or merger. These rights, in effect, allow the shareholder to have his/her interest bought out by the practice or his/her partners at fair market value before the sale. Should a minority shareholder choose to invoke his/her dissenters' rights, he/she must follow a very specific procedure (which varies from state to state). These rights do not, however, give the minority shareholder the ability to prevent the PE deal from moving forward.
But what does this mean, practically? There are considerations that need to be made before a shareholder decides to invoke his/her dissenters' rights. First and foremost, the minority shareholder may not receive as high a payout had he/she went along with the PE deal. If the parties cannot agree to a purchase price for the shareholder’s shares, a court may be required to determine the “fair market value” of the shares. Although the court may look to an offer from a PE company as a determining factor, the court is not necessarily required to accept that the PE firm's offer is consistent with the fair market value for the shares. Further, the minority shareholder may be required to pay the court costs and attorneys’ fees incurred by the practice to obtain this purchase price determination. So there is financial risk.
In addition, although the dissenting shareholder will avoid employment by the PE company, the shareholder, if he/she has a non-compete clause in his/her employment agreement, will almost certainly need to respect the terms of the non-compete.
So, would the dissenting shareholder be better off accepting the PE offer and then subsequently terminating his/her employment with the PE firm? Perhaps. But this may not be an option if the new employment agreement locks the shareholder’s employment for a lengthy period of time (e.g., doesn’t allow for voluntary resignation for three (3) years) or charges a penalty for premature termination.
Unfortunately, not all shareholders necessarily have the right to dissent to a PE deal or other practice sale. A shareholder may have waived these rights by agreeing to a “drag along” provision in his/her existing shareholders’ or buy-sell agreements, or another agreement among the shareholders. A drag along provision requires a shareholder to go along with a sale even if he/she votes against it (assuming the required vote is otherwise achieved). It is possible, if not likely, that the courts would view the drag along right as a preemptive waiver of dissenters' rights – in effect, the shareholder is agreeing to the sale in advance.
Younger to middle aged shareholders have a lot to think about when their practice is considering selling to a PE company. It is important that the shareholders know their rights and whether it is worth (financially and professionally) dissenting to a PE deal proposed by the majority shareholders.