The organizational documents of a business generally include the documents used to form or organize the business (registration documents) and the operational documents used to control activity within the business (operational documents).
The organizational documents are known as the declaration of partnership for partnership; the articles of organization for LLCs; and the articles of incorporation for the corporation. The filing of these documents to form the business entity is discussed in Overview of Forming a Business Entity and within the Startup Legal Resources Library.
This lecture focuses on identifying the operational documents that control the internal operations of the business.
Operational Documents contains provisions regarding the percentage of ownership of each owner, the role of each owner in the business operations, and the authority of each owner to make decision and bind the business. Whenever a business has more than one owner and no ownership agreement in place, then state law controls. In most situations, the default rules call for equal ownership, equal control, and equal profit/loss sharing between owners. While this may be the owners’ intent, it is still advisable to have a thorough ownership agreement to address the litany of issues that can arise during the life cycle of the business.
Ownership and Control Rights
The ownership and control of a business generally begins with an agreement between the owners – founders and managers. Ownership agreements generally outline:
- Control of the entity (or authority to act on behalf of the entity in carrying on business),
- Percentage of entity ownership,
- Entitlement to profits and responsibility for losses.
Each type of business entity has a different operating, management, and ownership structure. The business ownership agreement that you employ depends on the entity you choose to operate your business or venture. After selecting a business entity, each of the above consideration arise in drafting the ownership agreements.
Sole Proprietorship (No Formal Document)
A sole proprietorship is a company with only one owner. Therefor there is generally no issue of control or ownership of the business operations. Starting the sole proprietorship requires no paperwork. It is not registered with the state, unlike a limited liability companies (LLC) or corporations. As such, there is no legal requirement to file any formal document in place. All you do to create a sole proprietorship is simply go into business. No ownership agreement is required, so the business plan often serves as a guide for planning operations.
Partnership Agreement (PA)
The PA should outline the control of each partner of the business, the partner’s ownership interest, and the duties and responsibilities of the partners. Below are the important aspects to address within the PA.
- Governance – Outlines rules governing the business
- Relationships – Establishes an understanding of the business relationship that exists between the partners.
- Duties and Responsibilities – The regards the position that each partner will assume in the business operations
- Profits – Rights to or allocation of benefits or profits.
- Dispute Resolution – It serves as a base to deal with problems that arise in carrying on business.
- Leaving the Partnership – Determines the procedures and rights for when a partner leaves the business.
Without a PA, the default state law rules for Partnership operations apply. With this in mind, It is always better to have a planned, customized partnership agreement in place that meets the needs of the individual partnership.
LLC Operating Agreements (OA)
Individual state law determines whether an LLC is required to write out an operating agreement. (See your state Code of Laws).
The purpose and elements of an OA are as follows:
- Ownership – Lays out ownership percentage and the profit and loss sharing between between the members.
- Authority – Duties, obligations, voting rights, etc.
- Managerial structures & Governance – (i.e., Member-managed or manager-managed. Rules for meetings and voting.
- Decision making – Procedures for decision-making about the business
- Exiting the Business – What will happen in the event that one of the owners decides to leave the business.
- Disputes – Avoid or alleviate misunderstandings between members.
- Default Rules – State laws control by default without an OA in place.
A corporation must file articles of incorporation (formation) and ByLaws (Operations). It may but is not required to file a shareholder’s agreement (Ownership). The purpose of the corporate bylaws is to lay out the operating procedures that the corporation. At a minimum, a corporation’s bylaws will cover:
- Name, address, and principal place of business
- Directors and corporate officers
- Election or appointment procedure
- Terms of Service
- Stock (number of shares and classes) that the corporation is authorized to issue.
- Governance Procedures:
- Director and shareholder (s/h) meetings
- Shareholder, director, executive actions
- Corporate record-keeping
- Amending articles of incorporation and bylaws.
Corporate Shareholders’ Agreement (SA)
The SA is an agreement among the shareholders (owners) of the company regarding their ownership interest. These are consensual and are usually formed to serve a particular purpose or settle an issue. The SA is not generally publicly filed (unless the terms or content mandate disclosure to investors). Elements: A SA will vary depending on the purpose, but common provisions in a SA are:
- Who can be a shareholder;
- Procedure if the shareholders leaves, dies, or is fired;
- Who can serve on the board of directors;
- Management of the company;
- How the company should be operated
- Shareholders’ rights and obligations;
- Information on the regulation of the s/h’s relationship.
- Ownership of Shares – privileges and rights of shareholders;
- Valuation of the stock for internal purposes;
- Entitlement or obligation to repurchase shares;
- Procedure for the repurchase of shares.
Regardless of the type of entity you choose for your business, it is advisable to have an ownership agreement in place. We cover ownership agreements in greater detail in the Startup Legal Resources Library