Maintaining a clean and tidy home is the basis of a successful family life. When everything is in order, things are going well. A private company must also keep its “house” in order. But what does that mean?
Every business should have certain essential documents to point it in the right direction, avoid legal pitfalls, guide it through litigation, and establish the corporate veil that protects owners from exposure to personal liability. The information in these documents is also essential in positioning a business for sale, raising capital, and complying with lender demands.
Despite the benefits of having foundational documents in place, advising hundreds of private companies, I consistently find that key documentation has never been created or is outdated, incomplete or missing.
In many businesses, the job of the legal department is to make sure the house is in order. In others, this responsibility lies with the CFO, who relies on an outside lawyer for assistance. It is an easy task to overlook. Yet it shouldn’t be. Not having essential documents in place, up to date and easily accessible can increase risk and hamper growth opportunities.
A private company should have the following documents handy:
Operating agreement or regulations
The rules of operation of the company.
In a limited liability company, an operating agreement specifies the members, the rules by which the company will be managed, the capital contributions already made and to be made, and the distribution of profits. Some may include provisions preventing the sale of memberships to third parties or establishing procedures for resolving disputes between members. Putting these rules in place (or taking the time to update them) is essential if the company is sued, if a member dies, or if members decide they can no longer work together.
Likewise, in a company, the articles of association set out the rules and regulations of the company. They provide advice on the officers that the company will maintain, the duties of each, the voting mechanisms for the board of directors and the rights of shareholders. How decision-making is conducted, including who needs to be present to make decisions, is also discussed. These provisions are also important in the context of litigation, a sale of the business or a major action such as the acquisition of another business or obtaining financing.
Ownership and transfer records
Historically, the tracking of business ownership and transfers was done on a stock ledger. Many legal persons still keep one. However, with the advent of limited liability companies and the deformalization of corporate organizational structures, ownership records often fall through the cracks. In many private companies it is clear who owns what. The question can quickly become complicated when shareholders or owners die, divorce or when employee shareholders leave the company without selling their shares. Transfers should be clearly documented by assignments and consent resolutions confirming the transactions that have taken place.
Private business owners will often do anything to keep the business afloat during economic downturns, including lending funds to the business. When this happens, it is important to document these transactions with promissory notes or other loan agreements. Having these documents is crucial when an owner, member or shareholder makes a financial commitment and expects the company to reimburse them. Having all of the financial documents supporting loans and other transactions between the business and its owners keeps everyone on the same page and increases the likelihood that financial obligations will be met.
Purchase and sale contracts
In consultation with a lawyer, each private company must design and document a buy and sell agreement. Sometimes referred to as a shareholder restriction agreement, this document prevents the sale of shares outside the control of a private company.
It can also provide a mechanism for addressing the future of the business, what happens when a key employee leaves or retires, or in the event of an unexpected departure, disability or death. The buy and sell agreements also deal in advance with the value of owners’ interests so that there is no dispute over the buyback price upon departure.
Having a buy and sell agreement in place helps a business operate under uncertainty and endure for future generations.
When it comes to creating, updating, and accessing key documents, the needs of a private business are not of the same complexity as those of a publicly traded entity. However, the stakes are no less high.
Zana Tomich is co-founder of Dalton & Tomich, PLC, based in Detroit, Michigan. The firm provides external general counsel services to private companies.