Pop quiz: what was one of the main takeaways from our last business blog post? We'll give you a second (or two) to read it again and answer that question . . .
OK fine, we'll help you out: GET. IT. IN. WRITING. As promised, this edition is all about the foundational corporate governance agreements that essentially function as the "legal infrastructure" for your business. These include: (1) by-laws/shareholder agreements; (2) operating agreements; and (3) partnership agreements, each of which serve similar functions but apply to different entity types and corporate structures. For all of you lovebirds out there who just celebrated Valentine's Day, even though love is blind, your startup agreements should have a clear vision and roadmap for your business. Think of this as your business's prenup – you don't want any surprises.
By-Laws and Shareholder Agreements
For corporations, by-laws serve as the guiding principles governing internal operations. These agreements outline procedures for things like shareholder meetings, corporate decision-making, board of director appointments, voting rights, dividend distributions, and other essential corporate matters. Given that corporations are subject to higher degrees of oversight and reporting requirements, by-laws are critical not just from a corporate governance perspective, but from a legal compliance perspective, to promote full transparency and accountability within your organization.
In addition to by-laws, many corporations also have shareholder agreements, which are a bit more particularized. These agreements address issues such as share ownership, transfer restrictions, preemptive rights, and dispute resolution mechanisms. By establishing clear guidelines for shareholder interactions and responsibilities, having a shareholder agreement in place will help prevent conflicts and ensure that your company runs smoothly. This way, you don't wake up one morning to find out that your business partner has sold their shares to their neighbor's cousin.
By-laws and shareholder agreements go hand in hand and provide a comprehensive framework for managing the affairs of your company and safeguarding the interests of its shareholders. As is the case with all corporate governance documents, it's essential to carefully draft and regularly review these documents to adapt to changing circumstances and ensure all their terms are aligned with your company's short and long-term objectives.
Operating Agreements
Operating agreements are limited (pun intended) to limited liability companies ("LLCs"), and ownership interests are referred to as either "membership interests" or "membership units" (ownership in a corporation is through "shares"). Operating agreements clarify the roles and responsibilities of members, as well as mechanisms for decision-making and profit distribution. You guessed it, these are largely similar to corporate by-laws, just with a bit more flexibility and much less statutory requirements. By addressing potential scenarios and contingencies up front, operating agreements help mitigate risks and protect the interests of all parties involved. As we've discussed previously, LLCs are a bit less formal and have less legal bureaucracy – so this is certainly reflected in the operating agreement drafting process.
Partnership Agreements
Unlike operating agreements and by-laws, partnership agreements are the go-to document for partnerships. They're a bit more straightforward and provide a no-frills approach to corporate governance, outlining basic terms such as: each partner's respective ownership interest, decision-making and management of the company, and distributions.
Considerations for all Corporate Governance Agreements
Overall, whether it's by-laws, shareholder agreements, operating agreements, or partnership agreements, pay close attention to the really important provisions. Things like: indemnification, dissolution, removal of partners/owners, sale of ownership interests, tax matters, limitation of liability, confidentiality, and, depending on your industry, protection of the company's intellectual property (hint hint – you'll be hearing about this soon).
Overall, your corporate governance agreements need to be clear and cover all issues that apply to your company and management structure. Ambiguity is the enemy of effective corporate governance, and the enemy of any contract for that matter. Having clear language minimizes the likelihood of not just confusion, but stakeholder disputes.
Your agreements should also be drafted in a way that provides for a bit of flexibility, otherwise, as you grow, you'll have to revamp them and start all over. For example, you shouldn't have to redraft these agreements as you add or remove partners. Covering these potential changes in circumstances will set you up for success. At the end of the day, you want to account for not just your day-to-day operations, but best practices in the event of a worst-case scenario, and that applies across the board. And, as discussed above, these agreements are subject to certain statutory requirements, so while you have some flexibility with respect to how you want to run your business, you still need to make sure that the provisions you include in your agreements actually comply with applicable law.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.