As an investor of a business, how do you prevent the founder from holding back growth?

Question

If you are an investor who owns 30% of a business and the founder owns 70%, how do you prevent a situation where the founder decides to always take profits and not reinvest them to grow the business? Eventually, as an example, the founder uses the profits he took to start and focus on another similar business, which he will own 100%. Then leaving the business that you're part of on a plateau.

Answer 1

Derivative action

One typical solution that is available in most or all North American common-law jurisdictions would be a derivative action brought on behalf of the corporation against the person who is dissipating its assets. This is an equitable remedy. Whether a personal right of action or a derivative action is appropriate generally depends on the nature of the loss. See e.g. Anthony v. NPV Management Ltd., 2003 NLCA 41 at para. 14, quoting McGinness, The Law and Practice of Canadian Business Corporations:

Derivative actions must be distinguished from personal rights of action belonging to a shareholder. In deciding whether a particular cause of action is derivative or personal, the question to resolve is whether the essence of the action is the violation of some right of the corporation or some personal right to which the shareholder is entitled. Either one can produce a loss to the shareholder. The difference is whether the loss is suffered by the shareholder directly or by the reduction in the value of his or her shares.

I am not sure that this reflects the exact boundaries of the availability of this action in other jurisdictions and I would expect there to be jurisdiction-specific thresholds/tests/procedures to establish a valid derivative action.

Dissipation of assets

Commonly, a derivative action will claim that a defendant has dissipated assets of the corporation. E.g. in Anthony v. NPV Management Ltd., the claim was (among other things) that

• "the Defendants dissipated or permitted the dissipation of the assets and transferred business of Conpak Seafoods Inc. to Daley Brothers Limited" and that
• one defendant "acted in such a manner to serve his personal objectives to the detriment of Conpak Seafoods Inc. and its Shareholders."

In this overview article, Aronson et al. describe a derivative action as follows:

‘the action is derivative, i.e., in the corporate right, if the gravamen of the complaint is injury to the corporation, or to the whole body of its stock or property without any severance or distribution among individual holders, or if it seeks to recover assets for the corporation or to prevent the dissipation of its assets.

This answer by ohwilleke presents another good description.