Business Entities: Governing Documents
A crucial component to forming a business entity properly is carefully crafting the documents that will govern the organization in the daily operations and management of affairs, the relationship between the owners and those managing the operations, and the process of dissolving the business or making other substantial decisions in the course of the business cycle.
The names of the documents differ depending on the type of business entity that is used. Because of the different nuances among states, this article will focus on Texas.
All entities that provide liability protection in Texas are formed by filing a Certificate of Formation with the Texas Secretary of State. However, that is just the beginning.
Can’t I just do things the way I want? It’s just me. Or … my co-founder and I have a mutual understanding about how this is going to work.
While things may be fine now, they may not always be. You don’t have to search long to see that disputes among business partners happen frequently. An oral agreement (or even worse an unspoken understanding) just won’t cut it.
Just like tech, law has lingo, too. Below are a few key terms you need to know:
a Partnership is governed by Partnership Agreement
a Corporation is governed by Corporate Bylaws
a Limited Liability Company (LLC) is governed by a Company Agreement
Aren’t all those terms just the same thing?
Sort of, but not really. While these different business entities have similarities, a crucial component to drafting these documents is knowing what happens when a provision is not present. Due to their longer history, corporations have some of the most detailed provisions and requirements in the state. This provides great certainty to investors and the public, but can be frustrating to work within depending on the nature of a venture or startup.
In a similar fashion, partnerships can provide great flexibility and other important advantages, particularly with respect to taxation. However, formalities and default provisions provided through state statutes can be disastrous without careful consideration and planning.
Finally, the state statutes for default rules concerning LLC are perhaps the most minimal and provide the greatest flexibility for entrepreneurs to utilize. However, because of the minimal nature of default rules it is imperative to consult an experienced business lawyer to advise and guide you through this process.
What is in the governing documents?
The governing documents put forth the rules for voting on decisions such as who will sit on the Board of Directors and what vote is required for the business to merge or be sold. It also may contain provisions on how the management of the company will work. Will there be a manager who is not an owner or will the owners be the managers? If someone wants to sell their ownership, who can buy it? Anyone? Only other current owners? How much would it be for?
All of these questions and more can be outlined and dealt with in the governing documents. Having these discussions while the business is still in an optimistic and cooperative mode will make things much smoother than if situations begin to deteriorate.
Aren’t there model agreements that I can use for free?
The old adage “Nothing in life is free” remains true. While the internet abounds with ‘model agreements’ or ‘simple LLC agreements’, they can be more hazardous than having your password be ‘password’. These documents and software programs often do not make the distinctions and appropriate choices based on location, capital structure, jurisdiction, and formalities required for a particular endeavor. Without professional advice, governing documents with little oversight can put the founders in weaker positions when seeking outside investors, when it is time to sell, or dissolve the venture. Failure to properly follow the laws and regulations set forth can leave founders exposed to company debts and even lawsuit liability.
This sounds pretty overdramatic. It is just the two of us in this business …
Right now, you think you only have two founders. But, how many people do you get supplies from? How many people do you sell your services or products to? What are your expansion plans? Heck, what is the end goal for your business? Chances are that the answers to all of these questions go beyond simply the two people now involved. Carefully drafted and well thought out governing documents provide the certainty and protection founders and investors need in order to achieve their objectives.
In order to get the most out of your business entity, governing documents are a crucial component to the foundation of a business. By clearly reconciling different business interests at the beginning, developers, investors, and founders can prioritize the goal of scaling their business rather than dealing with problems that will continuously arise if not done correctly.
For more insights on Business Entity Formation, see our Corporate & Commercial Overview and Industry Focused Legal Solutions pages.