Why You Need Shareholder, LLC, and Partnership Agreements

What is a Business Ownership Agreement?

Ownership Agreements are the agreements between the owners of a business regarding who owns the business, each owner’s proportionate ownership, and some basic ground rules regarding operation of the business.  These documents are usually known as:

  • Shareholder’s Agreement (for corporations)
  • Partnership Agreement (for partnerships)
  • Operating Agreement (for limited liability corporations)

Though used for different types of business organizations (corporation, partnership, or LLC), these agreement are very similar in nature and purpose.

Shareholder agreements, Partnership Agreements, and LLC Operating Agreement and important and necessary.  Most importantly, they identify the current owners of the business and how the join or exit the business.   They also describe important accounting and tax provisions, high-level operational matters (such as voting, delegation of decision-making to a president or chairman, how to handle disagreements between owners, competition between owners and the business).  The agreements often describe the process for an owner to sell his/her ownership interest (though these can also be found in a separate buy-sell agreement).

We’re Friends.  Why Do We Need an Agreement?

  • You should have a great personal and working relationship with your fellow business owners.  This does not mean you can skip the ownership agreement.  Eventually, there will be a disagreement between the owners and it may cause such a divide that best possible resolution is for an owner to sell its ownership interest.  If you agreement does not specify how to buy out another owner, everyone will be involved in a lengthy, expensive legal battle.
  • An agreement can protect minority interests with special provisions that require the minority owners’ approval before certain business actions can occur.
  • Likewise, an agreement can protect majority interests with “drag along” provisions that compel minority owners to sell its ownership interest when the majority owners want to accept a third party offer to buy the business.
  • At some point, an owner will want to sell its interest (retirement, disagreement, moving out of the area, etc.).  Do the remaining owners get first dibs at the sale?  How is the price determined?  These are important situations to be addressed by your agreement.
  • An agreement can protect the owners from personal liability if the business is sued or compelled to pay fines or settlements.
  • Even if the business has only one owner, a ownership agreement (here, either an LLC Operating Agreement or a Shareholder Agreement (for a corporation)) is one of the several steps used to separate the owner’s personal assets from the business assets.

The Pitfalls of the DIY Agreement

Though ownership agreements generally contain the same basic terms, each business and group of owners is unique and each ownership agreement will contain some unique provisions.   For this reason, I don’t not advise copying an agreement from another business or using an online fill-in-the-blank template.  A good business attorney will have an in-depth meeting with the owners to learn about the nature of the business, the industry, the owners and their relationships to each other, and the goals of each owner.

Lastly, when an attorney drafts an ownership agreement, it is important the attorney and all the parties understand who is the client.  Often, the client is the business and so the attorney is not representing the best interests of any one owner but is representing the to-be-formed business.   Your attorney should have each owner sign a conflict of interest acknowledgement/waiver so everyone understands the potential risks.

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