Why is it worth owning < 50% of a private company?

Question

Why is it worth owning < 50% of a private company? E.g. when investors invest in private companies and get less than 50%, or when employees of startups get small chunks of a company, couldn't the owners just put the profits into higher salaries for themselves, assets, etc.? When would the < 50% owners ever benefit? Assume that they are not in a position of ability to pair up with other owners and form a majority to use their voting rights.

Answer 1

Majority shareholders of private corporations have a lot of power, but it usually isn't unlimited. Limits on majority power may be imposed by the articles of incorporation. So, if you are thinking of becoming a shareholder you'll definitely wan't to have a lawyer review the terms of your purchase and the governing documents for the company. In addition, many jurisdictions impose fiduciary responsibilities on all the owners of a private corporation. As an example, here is an article on the fiduciary obligations of shareholders in privately held corporations in Illinois USA. Requirements of fiduciary responsibility may not save you from sharp dealing by the majority shareholders, but they at least gives you a leg to stand on when fighting against negligence or dishonesty.

Answer 2

The board of directors is ultimately in charge of setting the budget, dividends, salaries, etc. Often the board is made up of people who are stockholders themselves and are not employees drawing a salary. As a result, they have an incentive to maximize the profits of the company.

Answer 3

...couldn't the owners just put the profits into higher salaries for themselves, assets, etc.?

Yes, they definitely could, but that doesn't mean they will. Regarding employee stock, most (but certainly not all) small business owners that become successful take great pride in their employees, and feel that the company has grown as a result of having great employees. They therefore choose to return some amount of profits to their employees as a thank you, and also a motivator to help obtain and retain good talent.

The same is also true for outside investors, but to a lessor extent. If the company becomes known for greedily spending its profits in a way investors disagree with, they will lose interest. This will make it harder for the owners to obtain future investments or cash out on existing ones if they ever wish to sell their shares. This doesn't preclude the owners from completely taking advantage of the original set of investors though.