Preferential rights offer certain investors special privileges or protections, which is why business owners often use them to attract more investments.
While these rights can help foster business growth, they can also cause shareholder disputes. This is especially true when a company faces major changes or financial events.
Understanding these conflicts can help you prepare if your business faces such issues later. Below are some common disputes to watch out for.
Liquidation preference disputes
These disputes can occur when you sell, merge or liquidate your company. They center around the order and amount of payouts to different investors. Usually, investors with liquidation preferences have the right to receive their investment back before the other shareholders do.
However, conflicts can happen when there are multiple rounds of investment with different preferences.
Anti-dilution conflicts
Anti-dilution provisions help protect early investors from significant ownership dilution when the company raises additional capital at a lower valuation. When triggered, these provisions typically grant early investors additional shares to keep their ownership percentage.
Disputes can arise in several ways, such as:
- Provisions might give early investors more shares but reduce ownership percentage for new investors
- Preferred investors may disagree about the varying levels of protection
- Investors might disagree on how to calculate the anti-dilution adjustment
These can have significant consequences for your business, such as difficulty raising new money because of strained investor relationships.
Dividend rights disagreements
Dividend rights conflicts often revolve around the timing, amount and nature of dividend payments. Preferred shareholders typically get paid before common shareholders.
For example, different shareholder groups may disagree on how to handle dividends. Some may want immediate returns, while others prefer to put money back in the business.
Disputes can also arise between the company and its shareholders. For instance, if a company chooses to conserve cash instead of paying dividends, investors may file complaints.
How to protect your business while meeting investor expectations
Offering special benefits also means you must avoid any conflicts at all costs. As a business owner, taking precautions can help prevent these disagreements. Clear communication and transparency should be a priority, and so should proper financial planning.
However, major challenges can happen despite all your preparation. If you find yourself in the middle of a shareholder conflict, legal guidance can help protect your business while meeting obligations to your investors.
