51% vs. 49 % Ownership: Much More than a 2% Difference

We recently had the opportunity to advise a large multi-generational family business on matters relating to its divestiture of one of its subsidiaries. Several years ago, the company acquired a start-up venture as a complement to its core operation. The start-up was founded by a dynamic creative leader. The start-up built a service around selling its own branded products directly to consumers via one-on-one direct sales marketing. The parent company (funder) sells exclusively B2B.

The parent company was the majority shareholder with 51% ownership in the start-up company. The start-up founder was the minority shareholder with 49% ownership. In the beginning, both groups worked well together with few hiccups.

The start-up founder was reliant on the parent company for: ongoing financial help, product creation, product sourcing, supply chain, and product fulfillment operations.

For several years in the start-ups growth trajectory, the relationship was positive.

The parent company co-designed, sourced, manufactured, and imported into inventory new products exclusively for the start-Up. The parent company took the financial risk of holding the inventory and not charging the start-up until the items were sold.

However, once the start-up achieved significant sales traction, the start-up expressed an interest in buying out the parent company’s 51% interest and offered a purchase price well below fair value. As the parent company was interested in raising cash for its core business, it was not opposed to divesting itself of the start-up, but was offended by the start-up’s offer. The relationship between the parent company and the start-up subsequently soured.

The parent company countered with what it considered a fair sell price and included a plan for the start-up to purchase the remaining on hand inventory of the start-ups’ exclusive branded product. The start-up would not cooperate.
This is when the parent company asked Lift for insight.

Owning a majority interest and having an operating agreement which provides significant decision-making control to the majority owner was pivotal in the negotiations.

Because the parent company was the majority shareholder, they had a right (unless modified under the operating agreement) to appoint a majority of the board of directors’ members and to direct the CEO to fulfill their directives.
When the parent company felt the relationship “going south” and that a potential divestiture of the start-up was in jeopardy, we coached the parent company CEO on how to potentially seek a favorable outcome. We advised the company on how to best utilize its majority interest control as leverage to achieve not only a fair price but to also negotiate a favorable business plan for the start-up to purchase the remaining exclusive inventory at a fair price and have such inventory removed from the parent company’s warehouse.

When the start-up was put on notice as to what actions the parent company could take based on its majority control, including, among other things, selling its majority interest to a third party with “dragging rights” requiring the start-up to sell its ownership to such a third party. Now, the start-up was listening.

While the relationship had transitioned from a “favored child” to an “arm’s length fair market” dynamic, it is a healthier relationship to sustain going forward.

If the parent company had not retained a majority interest in the start-up with appropriate operating agreement rights, then the situation would have been much more difficult, expensive, and litigious.

The moral of this story is that 51% ownership carries a lot more than a 2% premium over 49% ownership. Majority rules!

Conversely, if you are looking to partner with another investor to build a company, and you will be the minority shareholder, then you need to be very thoughtful about what rights you “add” into the operating agreement to temper the majority shareholder’s rights.

Either way, we at Lift Insight & Capital Partners can help.

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