The Importance of Shareholders Agreements and Operating Agreements.

On many occasions, I have been asked to form a new entity for a client. In so doing, I ask all the typical questions, such as who are the owners, officers, managers, registered agent, office address, etc. When there is more than one owner, I always recommend that they enter into a Shareholder’s Agreement (for a corporation) or an Operating Agreement (for a limited liability company). I am often asked, “is it really that important and can I get away without one?” The answer is always, yes it is really that important and, quite possibly, you may need one for purposes of obtaining financing, opening a bank account or for other reasons. These Agreements are not only important for the operations of the business, but can be even more valuable when addressing a dispute between the owners.

Shareholders Agreements and Operating Agreements contain many different terms and conditions. The following is a list of items that are often included in Shareholders and Operating Agreements. This list is not exclusive to these items, but is a good reference to follow when discussing the terms with the other owners:

1. Company Name. Will it be operating under a fictitious name?
2. Have you discussed a business plan/model for the operations of the restaurant. If so, can any of this be incorporated into the agreement?
3. Who are the actual owners going to be – through entities or individuals?
4. Who are going to be the officers and directors (for a corporation) or the managers/members (for a limited liability company)? Will it be member managed (for LLC)?
5. Are there any up front capital contributions – is there a ceiling on capital contributions, what are the anticipated capital contributions?
6. Are there going to be any up front loans going to be provided to the company – if so by whom, how much?
7. What are the percentages of ownership?
8. How are the distributions to be made (percentage wise) and how often?
9. Is there a tax partner, ie., which one of you will be in charge of taxes?
10. Do you want to list each members’ duties and responsibilities?
11. Do you want to address fiduciary obligations of the owners?
12. Do you want any restrictive covenants pertaining to owners’ other interests, such as covenants not to compete?
13. Do you want to include anything concerning salary?
14. Discuss insurance issues – key-man life insurance (for the benefit of the entity)?
15. Who can make financial decisions – is there a maximum daily amount for an item, any expenses over $____ amount needs to be by majority vote, etc?
a. Are there decisions that must be made by the unanimous consent of both of you?
b. Is there a ceiling on how much one can pay without other’s approval?
16. Buy-Sell language – what happens if one of you wants to sell, one of you dies or becomes disabled?
a. Is there any restrictions on the sale?
b. Is there a first right of refusal by the non-selling member?
17. How is the cost to sell determined, ie., purchase/sale price?
18. Are there any existing commercial transactions that should be included or referenced?
19. Anything else that you feel is important to include in the agreement?

One of the most valuable reasons to enter into a Shareholder’s Agreement or an Operating Agreement at the time that you form the company or begin its operations, is that you have addressed most of the important issues related to your ownership interest in the business at the outset of its operations. I can tell you that disputes arise between owners of a business all of time. These disputes are typically never contemplated at the time the company is formed. Prudent business owners will have entered into comprehensive Shareholder’s Agreements or Operating Agreements to address these items in advance of the dispute or will at least set forth the procedure of how to address and possibly resolve the dispute. For more information on Shareholder’s Agreement and Operating Agreements, please feel free to give me a call.

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