FAQ Series

Business Law - Question #1:

What is the purpose of Operating Agreements and Shareholders Agreements and why is it important to implement these documents when I first form my new business entity?

Operating Agreement vs. Shareholders' Agreement

Both Operating Agreements and Shareholders' Agreements are essential as they outline the governing terms for how the structure of your business is managed, whether in the case of a business with multiple owners or a single interest holder. However, Operating Agreements specifically apply in the case of a company (such as a limited liability company) and Shareholders' Agreements specifically apply in the case of a corporation. In addition to the Shareholders' Agreement, corporations should also abide by a set of Bylaws which further outline the election and structure of the Board of Directors as well as other terms of the corporation's governing structure.

Significance of Operating Agreements and Shareholders' Agreements

A thoughtfully prepared and complete Operating Agreement or Shareholders' Agreement and Bylaws will address how the following situations, as well as others, will be handled within the life of your business entity:

• Transfer of business interests to family members;
• Transfer of business interests for estate planning purposes;
• Sale of business interests to third parties (and the corresponding rights of non-selling interest holders);
• The death of a holder of a business interest;
• The total sale of the company or corporation;
• The individuals or other entities in charge of running the day-to-day affairs of the business, such as incurring new debt, buying or selling property, hiring professional advisors, and other essential tasks. These individuals typically consist of a Manager for a company and Officers for a corporation such as President, Vice-President, Treasurer, and/or, Secretary.
• The rights of interest holders, including voting rights for major business decisions and the election of Managers, Officers, or Directors;
• Liability of Managers, Officers and Directors;
• Disputes among interest holders; and
• Forced capital contributions or calls.

Significance for Single Owner Businesses

In reviewing the list of topics often addressed in Operating Agreements or Shareholder Agreements, a business owner that owns 100% of their business may mistakenly believe that these types of documents are unnecessary for their business.  In fact, we often hear entrepreneurs express that they feel the agreements are overly complex. However, even a simple Operating or Shareholder Agreement prepares a savvy business owner for future events like adding additional interest holders or the sale of the business itself.  It can also help limit the business owner's liability exposure by demonstrating to third parties that proper business procedures are followed and that the business is truly separate from the personal assets of the business owner.

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