Two common types of small business formations are corporations and limited liability companies. If you have multiple owners of either type of company, it is important to make sure that the ownership structure is clearly defined and clearly understood by all shareholders or members. Operating agreements are used for limited liability companies with multiple members, and shareholder agreements are used for corporations with multiple shareholders. These documents can help ensure that your business is set up correctly so that you avoid business operation issues in the future.
Overview of agreements
An operating agreement is a document that sets forth the obligations and responsibilities of the members of the limited liability company. It essentially describes the rules for making business decisions by the members of the limited liability company. The operating agreement is a binding document that can be enforced by the courts. Limited liability companies can be very flexible and informal, or they can be highly structured legal entities with clear rules and obligations written down in contracts. Whether you have an operating agreement or not depends on how much structure you want your limited liability company to have. If you don’t have an operating agreement in place, then state statutes and case law will apply to determine the respective interests, duties and liabilities of the members. State laws vary widely on what they require of limited liability companies, so having a plan before problems arise is usually recommended.
Similar to an operating agreement, a shareholder agreement is used for corporations and can also be called a shareholder rights plan (SRP) or equity protection plan (EPP). This type of agreement sets out rules for shareholders who own stock in a corporation. The purpose of these agreements is twofold: First, it protects each shareholder from actions taken by other shareholders that might affect their ownership interest; second, it lays out how decisions will be made regarding major corporate issues such as mergers and acquisitions.
Operating agreement basics
As its name suggests, the operating agreement is an agreement that covers how your limited liability company will operate on a day-to-day basis. You will work out details like who can make business decisions, the financial responsibilities of each member, and how members can receive distributions from profits. For example, suppose you want to prevent certain people from making decisions without consulting others first or making sure everyone gets paid equally for their services. In that case, an operating agreement can ensure these things happen. It can also help protect against conflicts among members by clearly defining each member’s role in decision-making processes and setting out what happens if those roles change over time. Be sure to understand all of these things when setting up your limited liability company because you will not be able to amend the operating agreement later without all of the members agreeing to do so. It is also important to note that in some states if you do not have an operating agreement in place, your limited liability companymay not even be considered a valid legal entity. Arizona does not require limited liability companies to have operating agreements.
What should be included in a shareholder agreement?
Though there are many reasons to create a shareholder agreement, you will most often create one in order to address ownership issues. Some of these issues may include how much equity each shareholder holds or whether your company will be responsible for its shareholders’ business debts. You’ll also want to think about what happens if a shareholder wants to leave or is forced out of the business, or what happens when someone dies. The shareholders’ agreement can include provisions on voting rights, profit-sharing, buy-sell provisions, management structure, and other key issues you may not have thought about when you formed your business. A shareholder agreement can also outline exactly how decisions should be made, who should make them, and what happens if those decisions conflict with other agreements (like a partnership agreement).
How will disputes be resolved?
Have you ever entered into a business relationship with someone only to realize, months or years later, that things aren’t working out? Perhaps one party is doing all of the work while another reaps all of the rewards. Maybe there are disagreements about how work should be divided or how profits should be split. With disputes arising so frequently, what do you do if your partner wants to dissolve your relationship? Enter into operating agreements and shareholder agreements helps to clarify these issues and provide accountability to members or shareholders. If you have multiple partners, members, owners, or shareholders in your business, it is essential to have an operating agreement or shareholder agreement in place before launching your business. Not having these agreements in place could lead to costly legal battles down the road. A dispute resolution clause might state that disputes must be settled by arbitration instead of through expensive litigation. This is important because arbitration costs less than litigation and takes much less time as well. When you consider that some court cases take decades to resolve, arbitration is a far better option for everyone involved! We recommend always having a dispute resolution clause in your agreement from day one (no matter how good your relationship seems). You never know when issues might arise, and being prepared for any eventuality by having a dispute resolution clause in your operating or shareholder agreement will keep you from being blindsided by unexpected legal fees down the road!
If you think you might need an Operating Agreement or Shareholder Agreement or you are involved in a dispute over either of these agreements, call Anthony Law Group at
602-362-2396. We will conduct a thorough review of your situation, strategize with you, and recommend the best course of action.