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Minding Your Own Business: The Importance of Ownership Agreements for Small Businesses

| Dec 4, 2017 | Uncategorized |

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Starting a new business is easy, especially in the Internet age. Go to the Secretary of State’s website, fill out a few forms, pay a filing fee, and boom – you are now the proud owner of a corporation, limited liability company, or limited liability partnership. But protecting your new business is a different matter. Few things are worse than investing your life’s savings into a new business only to find out years later that your business was not properly protected. For this reason, and many others, drafting appropriate shareholder, member, and partnership agreements is critical to protecting your business and the dreams you have for it.

Let’s take a basic corporation as an example. A corporation is formed by filing articles of incorporation. The articles specify basic matters regarding the corporation’s powers. A corporation also has bylaws, which will specify things like how many people serve on the company’s Board of Directors, the method of setting shareholder and director meetings, the process for dividends, and a variety of other matters.

However, these documents rarely provide all of the protection that a business owner needs. Suppose you and a friend form a corporation, with each of you owning 50%. At the beginning, you are likely on good terms. However, the good vibes won’t last forever. What happens when your friend wants to sell her shares to a third party that you don’t like or who doesn’t understand your business?

This is where ownership agreements can play an important role. Shareholders in Indiana corporations can enter into shareholder agreements governing the ownership and transfer of shares, voting rights, how to resolve disputes, and a variety of other things. The same is true for limited liability companies and limited partnerships, which can prepare operating agreements and partnership agreements, respectively.

In our example above, you and your friend can enter into a shareholder agreement requiring the selling shareholder to offer to sell to the other shareholders before selling to a third party. If you want to have more control, you can require company approval before any sale – as long as the requirement is not manifestly unreasonable. Be aware that Indiana law places restrictions on things that shareholders, LLC members, or partners can do.

It’s also important to think through your agreements. Suppose your shareholder agreement says that business decisions must be unanimous and, if they are not, then the disagreeing shareholder must sell their shares to the company. Sounds like good protection against an unreasonable partner, right? But what happens when your “friend” wants a salary of $200,000 per year, even though the company can’t afford it? If you disagree, you may have to sell; if you don’t, you may go out of business. Either way, you may end up in a very expensive lawsuit. A well-drafted agreement can prevent this situation before it occurs by limiting compensation or limiting the types of disagreements that will trigger a buy-out.

For these reasons and more, consult with an attorney before drafting important business agreements and whenever your business needs change. It’s still true that “an ounce of prevention is worth a pound of cure.”

If you have questions regarding the contents of this article, or other similar issues, please contact your HWE relationship attorney or visit us at http://www.hwelaw.com.