Start-Up Launchpad Blog

Startup Companies Beware: A Shareholder's Right to Obtain Sensitive Company Information - May 30, 2016

Wei-erh Chen

Issuing new shares can help a startup bring in new investors who infuse the company with much needed capital or attract skilled employees who provide the necessary skills, expertise and leadership to help grow the company. 

 

However, issuing new shares means that the founding owners will give up some of their potential economic gains and control because applicable corporate statutes generally give shareholders several significant rights, including:

  • Economic Rights: Shareholders typically invest in companies for economic gain, which can be achieved through a shareholder's right to receive dividends and the right to sell his or her shares.  Though neither of these rights is without limit, shareholders will generally have a right to participate in a company's economic gains.

  • Control Rights: Shareholders have the right to vote on important matters relating to the business, which gives them significant control over the startup. One of the most important control rights is a shareholder's ability to elect directors who oversee and manage the business.

  • Litigation Rights:  Shareholders are also able to seek judicial enforcement of their rights under certain circumstances.  For example, directors and officers owe fiduciary duties to the shareholders.  If a shareholder believes that a director or officer has breached his or her fiduciary duties, then the shareholder can seek enforcement of, and redress for breach of, management's fiduciary duties.  Additionally, upon the occurrence of certain events, shareholders will have a right to pursue an appraisal action to demand that the company "buy out" the shares for their fair value.

  • Information Rights: As a part-owner, a shareholder has the right to request certain information from the company, which may include sensitive or confidential information that the startup or its founders may prefer not to share.

These rights are bestowed upon each shareholder by statute and exist regardless of the number of shares owned by a shareholder. It also doesn't matter what contractual rights were negotiated by the shareholder  in his or her investment documents, the rights still separately exist under applicable law.

 

While founding owners oftentimes focus on the economic and control rights that are granted to new shareholders, founders should also be mindful of the complexities surrounding shareholder information rights.  The Wall Street Journal recently reported on the tension between minority shareholders who wish to obtain sensitive financial information for valuation purposes and company management who are not eager to share considerable financial information with people who own relatively few shares. Their concern is this sensitive information could be inappropriately or inadvertently released to the wider public. 

 

Despite company reluctance at providing company information when requested, the corporate laws in many jurisdictions-including in Iowa and Delaware-generally favor the information rights of the shareholder.

 

In Iowa, any company shareholder can access a company's articles, bylaws, certain board resolutions, shareholder meeting minutes, written communications to shareholders and a list of company directors and officers.  Additionally, upon demonstration of good faith and a proper purpose, a shareholder can also obtain a company's accounting records, written consents, committee minutes and a record of the company's shareholders.  Similar information rights also exist for members of startups that are organized as Iowa limited liability companies rather than as corporations.

 

For example, suppose an employee exercised her stock options and became a 0.25% minority owner in her employer Acme Inc., which is an Iowa corporation.  If that employee later leaves her job and joins a competitor while retaining her shares in Acme, the employee could continue to request and receive certain information from Acme, including accounting information upon showing good faith and a proper purpose.

 

What it means to startup companies:

Startups should be aware of both the benefits and challenges of issuing stock to new shareholders.  In particular, startups should understand that each shareholder-regardless of the number of shares he or she owns-has a right to obtain certain material and sensitive company information.  If a startup is concerned with a shareholder's requests for information or the potential for an inappropriate or inadvertent release of such information, consider contacting an attorney to discuss options for addressing these concerns.