When a Minority Investor Makes Sense
The role of the board in negotiating a minority investment.
By Paul L. Schaye

There are two extremes with outside money: Either it's from a bank that has no involvement in business operations, or the cash comes from a majority investor or buyout that takes away control from the current ownership.

However, there is a powerful middle ground boards can consider: minority investors. This option can allow a company to maintain control while securing the cash to move the company forward.

Last year Forbes Inc. became its own business news story when, for the first time in its 90-year privately owned history, the company sold a significant stake to an outside private equity investor. As Steve Forbes said, The partnership gives us a chance to move faster than we would have been able to do otherwise, both in the United States and overseas.

What Drives the Decision

When the board is given the option to consider outside funding from a minority investor, five key factors can drive the decision:

• Strong Upside for Expansion, Liquidity, and Diversification: Shareholders want to retain control while taking the next step to grow the business. A minority investor allows the owners to maintain their vision and reap more rewards in the future.

• Need for Business Counsel: Management and board members sometimes must acknowledge that their skill sets could limit the growth of the business. While minority investors do not take over the business, they can provide expert counsel to fill voids.
• Transformation in the Marketplace Requires Expertise: With globalization and the emergence of new markets, expansion will require both money and expertise. A minority investor can provide the resources needed to build relationships internationally.
• Making More Aggressive Business Decisions: When current owners have the option of taking some of their money out and still maintaining control, they can embark on new ventures they would otherwise avoid.
• Maintaining or Attracting Better Talent: Often a company wants to keep its star people or draw leaders in the industry who want to see a fresh dynamic in the company. That new energy can be infused by a minority investor.

Even if the minority investor is brought to the board by management with a potential arrangement in place, due diligence by the board is still necessary. Although a minority investor would have less control than a majority investor, the board members must assure the shareholders that they are getting the best possible transaction. The transaction must address both the financial arrangement and cultures of the company and the investor.

Questions to the Investor

When the board conducts an evaluation, here are some key questions the prospective minority investor must answer:
- How does our company fit into your investment strategy?
- What motivates your decisions?
- Even with a minority stake, do you want to pursue changes in how the company is run?
- If our company needs more capital down the road, would it be available?

Questions about the Investor

The board should also ask the following questions when checking the minority investor's references:
- Were there any difficult situations in working together?
- Did the investor's attitude become less enthusiastic after the transaction was completed?
- If you had tripped covenants, how strictly did the investor enforce them?
- Was the investor heavy-handed in pushing for management changes?
- How did the minority investor create value that benefited all shareholders?

A Question for the Board

Finally, the board must ask itself, Are we ready to have someone else at the table with money at risk who will add another layer of accountability? The answer will help determine whether the minority investor is an asset or a liability.

In some cases, if management is pushing for a minority investor transaction, what management sees as a benefit to the company could be seen as a detriment by the board.

For example, if a minority investor is going to put in $150 million, that money could be as preferred equity or subordinate equity. While it might help grow the company in the near future, it could push back the shareholders in the capital structure.

All About the Relationship

Ultimately, board members must decide what is in the long-term interest of the company and the shareholders. It could be a matter of opinion how this new capital will be spent. For example, the management team might want to use the money to pay down debt, while the shareholders would rather pay out dividends.

The good news is that today investors have a lot of capital and are seeking out companies. Many are willing to take a smaller portion of businesses they participate in. Boards do not have to be as concerned about whether or not the money is out there; rather, the board can focus on whether the potential transaction will lead to a mutually beneficial relationship.