CHAPTER 7

Protecting Minority Investors

Introduction

What are minority investors? Minority investors have a minority interest in a company, which is a percentage of ownership that is significant but does not give the holder the right to control the company. What is the meaning of protecting minority investors? The protection of minority investors indicators measure the strength of minority shareholder protection against the misuse by directors of corporate assets for their personal gain. They also measure shareholders’ rights, governance safeguards, and corporate transparency requirements that reduce the risk of abuse. Why make a minority investment? Among those hundreds of thousands of privately held companies, many seek new or expanded market opportunities looking for cash for new equipment, and so on. A typical company has essentially three ways to obtain such financing: drawing on internally available funds, financing through external debt, or equity.

The Risks Faced by Minority Investors

The first option for obtaining financing is to source funds internally when the owner or owners get profits from current operations instead of ploughing them back into the business. However, this requires owners with financial reserves and patience sufficient to forego these profits. If the necessary reserves and patience are unavailable, the owners look externally for either debt or equity financing. If the company has a relatively predictable cash flow and assets to pledge, a bank loan can make sense, but if the company has less predictable cash flow and the opportunity has a greater upside potential, equity financing (new investors) can be a preferred option. The company ability to attract such external financing (investors) depends on many factors. One is the investor’s perceived risk of not receiving an adequate return within a foreseeable timeframe, either because operational plans fail to meet the objectives (business risk) or the investor’s rights are not respected (legal risk).

A new investor can give a business owner the chance to build a new partnership and provide additional liquidity. Majority shareholders would maintain control over most of the company important decisions, while minority investments can often:

The risks minority investors face in privately held companies can be complex and considerable. When unchecked by law or well-crafted shareholder agreements, a dishonest majority investor has substantial opportunities to shape company decisions for their own gain and to the detriment of minority shareholders. For example, a controlling shareholder may redirect resources from a company they own jointly to another that they own fully, thus swindling minority investors of part of the value of their equity stake. Without adequate safeguards that should be in place, majority investors could potentially do so with little transparency or room for minority shareholders to voice their opinions. Furthermore, by investing in companies not traded publicly on a stock market, minority investors have limited options to exit challenging situations.

Potential Challenges Faced by Minority Investors

Minority investors share ownership of a privately held company with individuals who, unless checked by other restraints, have de facto control over the company operations and information. This creates incentives for the controlling investors to divert firm resources from the company as a whole (where sharing is more likely) to other areas (where it is less likely). Some examples abound of controlling investors:

In the light of the aforementioned challenges, the term protecting minority investors has started to be considered pointedly on corporate governance in privately held companies.

How to Protect Minority Investors? Policies Encouraging Transparency

Minority investors cannot be protected without easy access to corporate information, but this information is only beneficial if it is complete and accurate. Annual audits by internal auditors and licensed external professionals help ensure this.

Doing Business 2020, a World Bank Group flagship publication, addresses transparency for minority investors in a privately held company by inquiring whether the company financial statements must be audited by an external auditor. It is nearly universally accepted that publicly listed companies should perform external audits. It is also nearly universally accepted that financial audits increase investor confidence.

Transparency and Participation Policies That Promote Minority Investor Protection

Doing Business provides policies that protect investors who actively seek to protect their interests. It inquires into three topics that promote informed minority investor participation:

These questions point to policies that facilitate investor participation in the limited company. The first two questions focus on factors that ensure controlling members (investors) cannot have the opportunity to meet to discuss matters pertaining to the company. The third ensures that minority members (investors) can have a say in what gets discussed when company members (investors) do meet.

Policies Helping Minority Investors Maintain Initial Agreement

Minority investors typically enjoy their strongest position when negotiating their initial investment. Three issues are considered for helping minority investors maintain initial agreements:

The first two questions point to legal provisions that give existing minority shareholders a say and right in any changes in the makeup of company membership. This can be very important for smaller companies where members often work closely with each other on behalf of the company, and the right mix of people is important. The third question points to provisions (e.g., a veto over asset sales) that give members a say in a transaction that would likely lead to a substantial change in the company profile. It also allows them to evaluate whether the sale benefits the company. As with rules facilitating minority investor participation, there appears to be few downsides to including the rules here, at least as default ones, in a company law.

Policies to Ensure Minority Investor Access to a Company Profit and Net Value Share

Two issues raised by Doing Business directly relate to the expectations of minority investors in sharing the fruits of the company operations and growth. The first issue Doing Business explores in this regard is whether a mandate exists to share a portion of the company profits in the form of dividends. Such a policy would help ensure that a controlling shareholder is not diverting funds to salaries or other projects that might disproportionately favor him or her. It also could prevent a well-known method of forcing minority shareholders to capitulate and agree to leave the company.

Dividend freezing, despite company profits, can be particularly maleficent for minority investors in laws that force them to pay taxes on these profits, even though they are receiving no payments. Because a controlling investor can often point to seemingly reasonable pretexts for refusing to pay dividends, such distribution mandates might not be effective unless mandatory and proactive. At the same time, policy makers should be cautious of creating mandatory rules that compromise company reserves and, thereafter, negotiators should be relatively satisfied with the agreement, at least from a legal risk perspective. There should be policies that help minority investors maintain the arrangements they have negotiated or to comfortably adjust to new conditions that might arise.

Institutions Facilitating Minority Investor Protection

Without effective supervision and enforcement, the letter of law and regulations have little meaning. The availability of competent and responsive institutions to enforce rights in the law books is even more important for investors of privately held companies. Such investors cannot simply sell their shares in response to corporate wrongdoing. Further, because privately held companies tend to be less well known, these companies are generally less susceptible to bad publicity that minority investors might be able to generate if they have uncovered misdeeds in corporate governance. This urges institutions and other mechanisms, including government agencies, courts, and alternative dispute resolution mechanisms, to facilitate minority investor protection.

Government Agencies

An important factor in enforcing minority investor rights in publicly traded companies is the work of security regulators and, in many cases, stock exchange and self-regulatory organizations.

Courts

Most of the burden of enforcing the rights of minority investors in privately held companies falls on investors themselves. Their primary source for the vindication of their rights is the court system where the company they have invested in is incorporated.

Egypt Business Regulation: Benchmarking

We have to know the economic situation of Egypt before starting any new investment. Benchmarking is a tool we use to measure your current situation with regard to others. The strength of business environment is scored on the basis of economy performance in each of the 10 areas included in the Ease of Doing Business ranking. In the Ease of Doing Business ranking, Egypt scored 114 out of 190, with score being 60.1 as shown in Figure 7.1.

It takes multiple times longer than normal to begin a business in the economies positioned in the last 50 than it does in the top 20. Moving property in the 20 top economies requires under two weeks, contrasted with around a quarter of a year in the last 50. Getting a power association in a normal base-50 economy takes twice the time it takes in a normal top-20 economy. The expense of such an association is multiple times higher when communicated as a portion of pay per capita. Likewise, business contest goals endure about 2.1 years in economies positioned in the last 50 contrasted with 1.1 years in those positioned in the top 20. Outstanding contrasts among the more grounded and more vulnerable performing economies are likewise clear in the nature of guidelines and data.

Figure 7.1 Egypt business regulation: benchmarking

The Cost of Starting a Business Has Fallen Over Time in Developing Economics

Nowadays, there is a big opportunity of doing business for low-middle-income economies than last years. The steps and measurement of opening new business are discussed in the following pages.

Figure 7.2 The cost of starting a business has fallen over time in developing economics

Source: Doing Business–Embed this chart—Download Image

The Steps and Measurement of Opening a New Business

1. Starting a Business

In Egypt, to start a new limited liability business, it needs the efforts of five men and takes 12 days to obtain and finalize the paper work of registration for the new business with cost 20.3 percent income per capita.

Starting a Business in the Arab Republic of Egypt—Scores

Figure 7.3 The steps and measurement of opening new business

Note: The employing workers and contracting with the government indicator sets are not included in the ease of doing business ranking.

Meanwhile, to start the same business with the same specifics but by women, it needs 6 women and 13 days to finalize the registration process with same cost.

The procedures of obtain the required registrations for a new limited liability business in Egypt:

2. Dealing with Construction Permits

This is the second step, which is building a warehouse, and it measures the procedures, time, and cost for obtaining the necessary licenses, permits, and submitting all required notifications.

In Egypt, building a warehouse requires 20 men and 173 days with the estimated value of EGP 2,199,243.60, and this costs about 1.3 percent of the warehouse value.

Dealing With Construction Permits in the Arab Republic of Egypt—Scores

The procedures of dealing with constructions permits in Egypt:

3. Getting Electricity

This step is required to obtain permanent electricity supply for the newly constructed warehouse. In Egypt, to obtain the permanent electricity from South Cairo Electricity Distribution Company (SCEDC), this requires five men, 53 days, and 180.2 percent income per capita.

Getting Electricity in the Arab Republic of Egypt—Scores

4. Registering Property

This step is the standardized case for an entrepreneur to purchase and register a land and a building. It measures the quality of the land from five aspects: reliability of infrastructure, transparency of information, geographic coverage, land dispute resolution, and equal access to property rights.

In Egypt, this procedure requires nine men, 76 days with cost 1.1 percent of the property value, and the quality of the land administration index, which is determined by scale from 0 to 30. The quality of land in Egypt is 9 on the quality scale.

Registering Property in the Arab Republic of Egypt—Scores

5. Getting Credit

This step relates to getting funds, assessing the lending facilities, and bankruptcy laws.

In Egypt, the strength of the legal right index, which provides production of secure creditor rights is 5, depth of credit information index is 8, while the percentage of adult population in the largest credit bureau is 31.5, and credit registry is 9.5.

Getting Credit in the Arab Republic of Egypt—Scores

6. Protecting Minority Investors

This step is the protection assessment for the shareholders from the personal misuse of the assets by the managing directors.

Protecting Minority Investors in the Arab
Republic of Egypt—Scores

7. Paying Taxes

This step pertains to monitoring and listing the taxes and mandatory contribution that is forced by law within the fiscal year, and assigning on whom these tax reports, compliance, and payment burden falls. In Egypt, the number of payments/year including consumption taxes is 27; the time required to collecting information, preparing separate taxes, completing tax return, arranging payment is 370 hour per year; the percentage of profit or corporate income tax, the social contribution labor taxes paid by the employer, and the financial transaction taxes are 44.4.

Paying Taxes in the Arab Republic of Egypt—Scores

8. Trading Across Borders

This step discusses and measures the cost and time of exporting the company comparative advantage product and importing the needed parts to carry over the business.

In Egypt, time to export, border compliance per hour is 48, while the cost to export, border compliance is USD 258.

Time to export, documentary compliance per hour is 88 (preparing and submitting documents during transport, clearance and the documents required by the destination economy, all documents required by law and in practice), while the cost to export, documentary compliance is USD 100.

Time to import, border compliance per hour is 240 (handling and inspections that take place at the economy port or border), while the cost to import, border compliance per year is USD 554.

Time to import, documentary compliance per hour is 265 (loading or unloading of the shipment at the warehouse or port/border), while the cost to export, documentary compliance is USD 1000.

Trading across Borders in the Arab Republic of Egypt—Scores

9. Enforcing Contracts

This indicator estimates the time and cost that may result in resolving any commercial dispute in front of a local first—instance court and also evaluating the quality for judicial process index among countries and the efficiency of the court system.

In Egypt, time (days) for filing and serving cases, trill seeking and obtaining judgment, and for enforcing judgment is 1,010 days, while the percentage cost of claiming value through courts, which includes court cost average, attorney fees, and enforcement costs, is 26.2, and for quality of judicial processes, court structure and proceedings, and case management is 4.0.

Enforcing Contracts in the Arab Republic of Egypt—Scores

10. Resolving Insolvency

This step measures the time and cost of resolving insolvency if it occurred among countries.

In Egypt, the time required to recover debt (years), measured by calendar and extensions are also included, is 2.5, while the percentage cost of recovered debt (court fees, law fees, insolvency administrators) is 22.0, of outcome (whether business continues operating as a going concern or business assets are sold piecemeal) is 0, and of insolvency framework index, of commencement, of proceedings index, and of reorganization proceedings index is 9.5.

Resolving Insolvency in the Arab Republic of Egypt—Scores

Conclusion

As per this study, Egypt has a comparative advantage in starting a new business in some rankings. Egypt got the highest scores in facilitating the establishment of a new business with a score 87.5 percent higher than the other economic capitals.