When the Minority Rules in SmallCap World – a lesson learned

PUT FORWARD BY NOMAD FOR APPOINTMENT AS NON-EXECUTIVE CHAIRMAN OF AN AIM COMPANY WITH PRIMARILY PASSIVE, SMALL INVESTORS AND WITH A SINGLE INFLUENTIAL INVESTOR.

My involvement

Appointed as non-executive chairman of an AIM company. A dominant shareholder controlling just over 20% had firm views on actions the board should take. He had established a parallel business traded on a different Exchange, where he held an influential position via shares and a board position. There were risks of market confusion due to the existence of two apparently connected but separate businesses, active in the same business sector, which at times partnered in JV arrangements (the parallel business produced opportunities but did not possess its own proven technology). A succession of directors, including previous chairmen, had left the board of the AIM company for their own reasons. The nomad identified me as a candidate for the vacant non-executive chairman’s role. The role required leadership of a board which the dominant shareholder was not slow to put under pressure. There was always a risk of conflict between his interests in the new company and those of the near-80% majority of the AIM company which had no other shareholders with significant holdings. For the most part, it was the typical picture in SmallCap World of passive small investors following the fortunes of an active significant investor. The difference in this case was that the single significant investor had an influential stake in the parallel business and the risk always existed of value drifting between the two, even if not by design. The dominant shareholder’s ultimate lever was a combination of, first, the inalienable ability in English law for a simple majority of shareholder votes to remove directors and, secondly, the reality in SmallCap World that a holding of around 20%, when voted, is very likely to wield 50%+ of total votes cast. A “relationship agreement” with the nomad was negotiated to be effective only for so long as the shareholder controlled 20% or more of total votes. So the agreement fell away when the holding was reduced to marginally below 20%. The shareholder became able to vote in his own sole interests. So, when the AIM company board members, against that individual shareholder’s wishes, shared an independent approach focussed only on the interests of the AIM company, a head was always going to roll, and none more telling than the Chairman’s. For me as Chairman the choice, notwithstanding the consensus board view, was to step down or be voted out on a shareholder requisition. A requisitioned EGM would have had consequences for the company from choosing to fight a costly battle it could not realistically hope to win. Shareholder votes rule.

Outcome

Facing Hobson’s Choice, I stepped down from the board, enabling the shareholder to pursue his dialogue with the remaining directors and the nomad. The nomad left six weeks later. The lesson learned is that, when facing a large shareholder with dogmatic views, before simply saying “No, it’s not in our company’s best interests” the board should aim to accommodate the shareholder’s plans and, whilst the opportunity is there, try to build in safeguards and full risk disclosure. The passive small investors then have to decide whether they will in reality benefit sufficiently and proportionately from following the fortunes of the active significant investor, or whether they believe their capital could be applied towards other purposes if they do not withdraw it first. In this case, “minority rule” at c.20% prevented me from staying involved to steer the outcome.