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General Considerations

Your business's ownership agreement is the governing document that will serve as the touchstone for how your business is organized and operates. No other document will be so important to a wide range of areas related to your business and how it is structured.

Ownership agreements go by various names depending on the kind of entity you've created for your business. In a partnership, it's called a "partnership agreement." In an LLC, it is called an "operating agreement." And corporations have "bylaws" as well as perhaps a "shareholders' agreement."

These specific agreements are discussed below. But whatever it's called, there are several general considerations to think about that apply to any of these agreements.

  • Ownership Rights & Responsibilities: It may go without saying for a document called an ownership agreement, but the rights and responsibilities of the various owners is an important area for any of these agreements to address. Will the owners all have similar rights and responsibilities, or will there be various roles or classes among the owners? It is best to be clear about these matters from the start before differences of opinion arise and affect business operations.

    Your ownership agreement should also discuss whether and how any new or additional owners may be added to the business, as well as what happens in various scenarios ranging from retirement, death, incapacity, or insolvency. This is also the place to reach an agreement regarding whether the owners of the business will be able to have other businesses or projects - while part of the organization or after - that may or may not compete with the business.

  • Management Structure: Management structure is another important area that every ownership agreement should address. Who is it that will handle the day-to-day operations and decision making of the business? Will the owners do this themselves in their capacity as owners or will your business select or hire individuals to manage the company?

    The type of entity you've selected may constrain the structural options available here. For example, in a corporation, the management roles have to be distinct from ownership. (Although, it is common in a closely-held corporation for the managers and shareholders to be the same person.)

    But whatever way you want to run your business, it is important to be clear from the outset who has the authority to make management decisions and how those decisions are to be made and documented. For more information, please see the section on management structures on the business formation page.

  • Decision Making: Business decisions come in several varieties. Some relate to day-to-day operations, others to long-term plans, and still others affect the basic structure of the business or understandings of the owners. Your ownership agreement should address each of these areas and determine who gets the final say.

    Can an individual owner or manager make a certain decision unilaterally or should that sort of decision only be made by a unanimous vote of all, or all of some class of, owners? Even in a manager-run business, it is typical for certain sorts of decisions to be reserved to ownership. For example, management may be able to sell items in inventory, but not equipment or other assets necessary to maintain business operations.

    The decision to sell significant assets, like the decisions to dissolve the business or merge with another, generally belongs to the owners of the business - and even then generally requires more than a simple majority. Whether certain decisions should be reserved to management or ownership will depend on the needs and goals of your business. But it is best to be clear about these matters upfront so that your business can operate smoothly and limit disputes.

  • Contributions: Businesses need money to operate. And a new business will have to rely on the resources and resourcefulness of its owners in order to secure adequate funding. Once things are up and running, your business will hopefully generate a steady stream of revenue sufficient to maintain or even expand your business operations. But either way, it is important to discuss how your business will obtain funding both at the start and later on, if the need arises.

    As a result, your ownership agreement should detail whether initial or additional capital contributions are required from ownership, and how and in what share they will be required to make these contributions. If your business will seek loans or outside investment, your agreement should address any terms and conditions related to these sources of funding as well.

  • Distributions, Salaries & Dividends: Once your business is successful, you may want to start taking money back out of the business. Your ownership agreement should determine when, how, and how much money can be withdrawn from business capital and cash flows.

    Can ownership determine when to distribute excess cash or is that a management decision? How will the owners share or split any profits? Will some owners have priority over others? Will amounts paid be distributions, salaries, dividends or something like (like the repayment of a loan with interest)?

    Just as it is important to determine in advance how money will be contributed to the business, it is also important to reach any understanding upfront regarding how and when money can be taken back out of the business. Otherwise tensions may rise just when your business starts to become profitable.

  • Transfer Restrictions: Another important matter to consider upfront is whether owners should be permitted to freely transfer their ownership in the business. Often ownership interests, certificates, stocks, etc. are considered personal property which can - at least by default - be freely transferred even to unaffiliated third parties.

    This free transferability of ownership interests may be desirable to the person who wants to make the transfer. But the remaining owners may not be as pleased to be thrust into business with a new co-owner who is not of their choosing. Your ownership agreement is the place to define any desired limitations or restrictions on the transferability of ownership interests.

    How much flexibility the owners have here will depend on the type of entity they've created. But often owners can use rights of first refusal and buy-sell agreements in order to maintain control of the business with its original owners.

  • Dispute Resolution: Hopefully you and your fellow co-owners never have any significant disagreements. However, your ownership agreement should certainly address how any dispute will be handled before it arises. There are various methods available to businesses depending on the preferences of ownership. Negotiation and arbitration, in that order, are often useful strategies to keep your business out of court.

    Mediation is another option to protect your business and allow the various owners to share their perspective. Any of these are preferable to litigation, which tends to be considerably more costly and time intensive. Moreover, court records are public and may create a permanent stain on your business's reputation. By having a plan in place to solve disputes quickly, you can get back to focusing on business operations.

  • Modifications & Restructuring: Change is one of the few certainties in life. Owners may come and go. Your business may grow, expand, or evolve. Either way, your ownership agreement should describe the procedure or process for adapting to these changes as well as the voting requirements for making modifications to the business or its governing documents.

    You should plan how you and any other owners will respond to important developments before the situation arises and interests are potentially conflicted.

  • Exit, Sale or Dissolution: Nothing lasts forever, and when it comes to your business it is much better to plan your exit strategy or strategies from the beginning. Do you plan on selling off your share of the business, or dissolving the business and liquidating its assets? Will only one owner be exiting while others remain?

    Whatever the situation, your ownership agreement should carefully detail the steps the owners need to take to end the arrangement and whether there are any limitations or requirements on the exit strategy. As with the other considerations above, intelligent planning at the outset can save considerable time and expense down the road.

The Pote Law Firm works with small business owners to help them properly draft, revise, and review various sorts of ownership agreements. If you need assistance, Reach out, Today!

Partnership Agreements

Partners are two or more persons operating a for-profit business together, sharing in profits and losses. As a result, they can operate their business with only an oral agreement or without any explicit agreement at all. In this situation, default rules will operate to fill gaps in the arrangement, specifying the extent of the partners' rights and obligations as well as the conditions for important business events.

These default rules may already specify terms that work best for a particular partnership. But modifications, tailored to the needs of a particular business, are common. And regardless, prudent partners should wish to understand these rules before letting them govern the foundational conditions of their partnership.

As a result, even for a general partnership, it is generally advisable to prepare a written partnership agreement that addresses the business's specific needs and purposes, describes its structure, and details the rights and obligations of the partners - as owners, managers, and agents of the partnership.

Even for a general partnership, it is generally advisable to prepare a written partnership agreement that addresses the business's specific needs and purposes...

Depending on the business, a partnership agreement may be relatively short and simple or it may be very complex and technical. Regardless of the size of the business, it is advisable to prepare a written agreement as doing so allows all partners to have a meeting of the minds as to important events and known contingencies, before any such event has occurred.

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Partners in a general partnership should also be aware that without an explicit agreement to the contrary, that the withdrawal of any partner, whether voluntary or involuntary, will cause the dissolution of the partnership. A partner may generally withdraw at any time, but may incur liability to the partnership for doing so.

Where personal liability is limited, it is even more important for partnerships to have a written partnership agreement. This is due to the fact that the limited liability afforded to the partners may be legally disregarded in part because business formalities are not followed, which is difficult in practice if not defined upfront in a written agreement. To learn more about veil piercing, click here.

Moreover, if a partnership holds real property, the partners will need to create a partnership agreement in order to file it in the county where any such property is located.

The Pote Law Firm works with small business owners to help them properly draft and review partnership agreements and other ownership agreements. If you need assistance, Reach out, Today!

Operating Agreements

Operating agreements govern the arrangements among members (i.e. "owners") of limited liability companies (LLCs), a popular new business entity in Colorado and throughout the United States.

As with partnerships, default rules will operate to fill gaps in the business arrangement where agreement is absent or silent, specifying the extent of the rights and obligations of members as well as the conditions for important business events.

Unlike corporations, LLCs are often referred to as "creatures of contract" because the terms of operating agreements are legally required to be given "maximum effect." As a result, there is even greater reason for members to draft a document to govern their relationships and business as courts are even more likely to enforce its terms.

Adopting an operating agreement allows members to come together to reach an agreement with respect to their rights and obligations and the structure of their business. As with partnership agreements, this facilitates the smooth operation of the business as well as the avoidance of conflict and other disruptions.

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Like other ownership agreements, operating agreements range from simple, informal agreements to very complex arrangements. Regardless of the size of the business, it is important to consider these matters carefully.

LLCs also benefit from having a written agreement due to the fact that a properly drafted and implemented agreement will help preserve personal liability protection.

Like partnerships where personal liability is limited, LLCs also benefit from having a written agreement due to the fact that a properly drafted and implemented agreement will help preserve personal liability protection. This is because the liability protection afforded to members may be legally disregarded according to a theory of veil piercing when, e.g., personal and business assets or accounts are commingled, or the business is used improperly or fraudulently (such that it seems unfair to shield the partners from personal liability).

Having a written agreement at the outset allows members to implement the procedures laid out in the agreement which, when properly followed, maintain separation between personal and business finances and help avoid the sort of impropriety that leads to piercing the corporate veil. To learn more about veil piercing, click here.

By default, there are restrictions on the admission of new members, even the free transfer of membership interests is also allowed. However, operating agreements help here too, allowing members to draft any limitations or restrictions according to the agreements the members.

These limitations may also be drafted so as to prevent creditors who obtain economic rights in the LLC from participating its the management or from inspecting company books and records.

LLCs are relatively new and as a result there are fewer interpretive guidelines. While all states now recognize LLCs as a legal structure, tax and liability treatment is not uniform from state to state, and may vary depending on whether the LLCs is single- or multi-member.

If you need assistance with forming an LLC or drafting or reviewing its operating agreement, PLF may be able to help. Reach out, Today!

Bylaws & Shareholders' Agreements

Corporations are formed by filing Articles of Organization and formally adopting bylaws. As a result, corporations are legally required to enact bylaws. A shareholders' agreement is not required, but allows for agreement amongst owners with respect to the rights and obligations of minority and majority shareholders. In the case of conflict, such agreements generally take priority over company bylaws.

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Corporate Bylaws

Corporate bylaws are adopted either by organizing shareholders or the initial board of directors, and they set out comprehensive rules and regulations governing the business as well as the rights and responsibilities of the board of directors and officers.

The contents of bylaws will vary depending on the needs of the business or the type of entity. Generally, corporate bylaws will describe the classes of stock, the composition of the board of directors, and the leadership structure. Additionally, they almost always specify details regarding annual meetings, including notice, quorum and voting requirements.

Good bylaws will also cover important entity events and provide a clear statement of the purpose of the corporation and a description of its core product.

A corporation should strictly adhere to any procedures established through the bylaws in order to avoid a situation where the entity is legally disregarded. This is particularly true for smaller corporations where shareholders are active in management. To learn more about veil piercing, click here.

Shareholders' Agreements

Shareholders' agreements are optional agreements commonly used in smaller corporations, where organizing shareholders are more active in the management of the business. Such agreements help shareholders preserve involvement in management and control over ownership.

One of the ways this is done is by including buy-back provisions in shareholders' agreements, requiring shareholders who no longer wish to stay on with the corporation to sell his or her shares (or some percentage thereof) back to the corporation.

Along the same lines, shareholders' agreements may contain rights of first refusal, where a shareholder who wishes to sell or otherwise transfer his or her shares must first give the other shareholders an opportunity to purchase the shares.

Shareholders' agreements are optional agreements commonly used in smaller corporations where organizing shareholders are more active in the management of the business...

Shareholders' agreements also frequently contain buy-sell provisions, which state what should happen if a shareholder is unable to participate in management due to death, incapacity, or bankruptcy. In these ways the shareholders of smaller corporations are able to maintain greater control over their access to management and the composition of their fellow co-owners.

Although they should be drafted to be consistent with each other, it is important to be clear about if and when a shareholders' agreement may take priority over bylaws in the event of conflict. And, if possible, any such conflict should be removed by amendment.

Bylaws and shareholders' agreements generally contain their own procedures for amendment or modification, and they can both be changed without filing an amendment with the Secretary of State.

If you need assistance with forming a corporation or drafting or reviewing its bylaws or a shareholders' agreement, PLF may be able to help. Reach out, Today!

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