Greedy shareholder that does not want to dilute his portion

Question

What needs to be done or could be done if a company wants to raise capital and one of the shareholders doesn't want to dilute his shares and brands all the others as "too greedy".

The shareholders agreement contains an article of no dilution and demands full consensus to change that. Because the shareholder is richer than the others he is using that article to force the rest of the shareholders to dilute and thereby gain a big portion of the new company valuation.

Update

The company received an offer of $5M for 25%. That particular shareholder owns 15%. Every shareholder except him agreed to dilute proportionally. He says - based on a non dilution article contained in the shareholder agreement - that we should proceed but diluting all except him. He called the rest (85%) too greedy as the majority had to give up only 4% if he wins the battle. The company is raising by rounds and this round is for $5M, next for $40M and we presume that he wants to keep that 15% for many years

Answer 1

What can be done? Buy that person out or find a different method of financing the company.

You're not going to get very far calling that person greedy and framing the entire issue around that. The shareholder agreement includes a provision not to dilute. Either find a different funding solution or come up with a more compelling argument than that greedy person won't allow this to move forward.

Answer 2

A no dilution privilege is precisely that, a privilege and not a duty. There is no reason to believe the shareholder is being greedy, after all, they are adding risk to their own position at the same time. A no dilution privilege only gives the right to maintain a constant percentage, if there are no resources to protect or maintain that right then it vanishes as if it did not exist.

"Full consensus" is not a well-defined term. Hopefully, the articles of incorporation define what that means exactly or it will simply be a majority-rule based decision.

Unless he is the majority shareholder and controls the board, then he cannot force the shareholders to dilute. If he is the majority shareholder, then it was foolish to enter into a written contract regarding the firm when informal understandings and ideas mean nothing legally. If you believed you were going to be protected, but are not, then the lesson is to hire a good attorney to explain fully the set of scenarios that could happen in the future.

Things like this are very common with angel investments and venture capital investments. Indeed, they plan for it. If they insisted on the no dilution agreement, now you know why.

The only control you could have is to get a majority of the existing shareholders to refuse to expand the company and to choose a board that will support your interests.

EDIT

I realized that I didn't fully answer the question. The only real choice is to borrow money. Class B Common Shares have to get voting rights or they are not common shares. Preferred stock won't work here unless someone is very generous. Preferred stock is a creature of the tax code and unless one of the partners or a vendor is a corporation, nobody is going to want it. Debt issuance is your only escape from dilution if every partner cannot pony up their proportionate share of the needed funds.

You will want to visit a local attorney to see how the local judges would interpret "full consensus." Governance structures in corporations are important as is the language people put in charters and by-laws. Contingencies like this should be mapped out before capital formation and not after founding. A board of directors has a fiduciary duty to the shareholders and the firm. The language may be interpreted with respect to that duty if the issue is survival rather than expansion.

In the case of survival, a judge may reject an individual shareholder's veto if it kills the value to all shareholders. If it is about expansion, the judge may simply say "too bad." This is a question for a local attorney first and foremost. The judges in your county or parish may react differently than a judge in a neighboring county or state. There could also be decided law on this matter in your jurisdiction.

Answer 3

There are various ways that a company can raise capital without diluting shareholder stakes.

1. Have the company issue bonds. These are loans that the company will pay back with interest. Usually bond repayments consist of regular interest amounts during the life of the bond with a lump sum capital repayment at the end.

2. The company could seek to get a bank loan. This is pretty similar to taking out a bond except that bank loans typically have a shorter term than bonds and repayments generally have both interest and capital parts during the term of the loan so there is no lump sum capital repayment at the end.

3. The company could crowdfund a particular product. Crowdfunders would receive that particular product or other related rewards but would not get a stake in the company itself. There are a significant number of crowdfunding sites these days. Crowdfunding rules generally state that if the company fails to produce and deliver the promised product or products, they must return the crowdfunders' monies.